Question

Replacement Analysis

St. Johns River Shipyards' welding machine is 15 years old, fully depreciated, and has no salvage value. However, even though it is old, it is still functional as originally designed and can be used for quite a while longer. The new welder will cost $84,500 and have an estimated life of 8 years with no salvage value. The new welder will be much more efficient, however, and this enhanced efficiency will increase earnings before depreciation from $25,000 to $50,000 per year. The new machine will be depreciated over its 5-year MACRS recovery period, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The applicable corporate tax rate is 40%, and the project cost of capital is 11%. Should the old welder be replaced by the new one?

Old welder -Select-shouldshould notItem 1  be replaced.

What is the NPV of the project? Do not round intermediate calculations. Round your answer to the nearest cent.
$

Answer 1

Calculation of Present Value of Cash outflow
Cost of machine						$84,500.00
(It is at current time. So present value is same)
						___________
Present Value of Cash Outflow						$84,500.00
						__________
Calculation of Present Value of Cash Inflow
		Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8
Increase in Earnings		25000.00	25000.00	25000.00	25000.00	25000.00	25000.00	25000.00	25000.00
(50000-25000)
Less : Depreciation
1st year ( 20% of 84500 )		-16900.00
2nd year ( 32 % of 84500 )			-27040.00
3rd year ( 19.20% of 84500 )				-16224.00
4th year ( 11.52 % of 84500)					-9734.40
5th year ( 11.52 % of 84500 )						-9734.40
6th year ( 5.76 % of 84500)							-4867.20	0.00	0.00
		_________	_________	_________	_________	_________	_________	_________	_________
Profit before tax		8100.00	-2040.00	8776.00	15265.60	15265.60	20132.80	25000.00	25000.00
Less : Tax @ 40%		-3240.00	816.00	-3510.40	-6106.24	-6106.24	-8053.12	-10000.00	-10000.00
		_________	(tax benefit)	_________	_________	_________	_________	_________	_________
Profit after tax		4860.00	-1224.00	5265.60	9159.36	9159.36	12079.68	15000.00	15000.00
Add : Depreciation		16900.00	27040.00	16224.00	9734.40	9734.40	4867.20	0.00	0.00
		_________	_________	_________	_________	_________	_________	_________	_________
Yearly Cash Inflows (F.V.)       (a)		21760.00	25816.00	21489.60	18893.76	18893.76	16946.88	15000.00	15000.00
WACC = 11% or 0.11
P.V.F. = 1/(1+r)^n             ( b)		0.9009009	0.81162243	0.731191381	0.658731	0.59345133	0.534641	0.481658	0.433926
like for first year (1/1.11)^1,
second year 1/(1.11)^2 and so on.
		_________	_________	_________	_________	_________	_________	_________	_________
Present Value of Cash inflows		19603.60	20952.84	15713.01	12445.90	11212.53	9060.49	7224.88	6508.90
P.V. = F.V. /(1+r)^n (a * b)		_________	_________	_________	_________	_________	_________	_________	_________
Total Present Value of Cash inflows   =				102722.16
Calculation of Net present value
NPV = Present value of cash inflows - Present value of cash outflows
	= 102722.16 - 84500
	$18,222.16
NPV of project is $18,222.16. So project should be accepted.
Notes :
(1) Increase in earnings before depreciation shall be considered for calculations. As incremental earnings are relevant for capital budgeting decisions.
(2) In year 2, there is loss of $ 2040. So, tax benefit of loss shall be cash inflow for year 2.
(3) Depreciation shall be added back as it is not an outflow in cash. It is considered only for tax calculation.