Question

Replacement Analysis

The Gilbert Instrument Corporation is considering replacing the wood steamer it currently uses to shape guitar sides. The steamer has 6 years of remaining life. If kept, the steamer will have depreciation expenses of $650 for 5 years and $325 for the sixth year. Its current book value is $3,575, and it can be sold on an Internet auction site for $4,150 at this time. If the old steamer is not replaced, it can be sold for $800 at the end of its useful life.

Gilbert is considering purchasing the Side Steamer 3000, a higher-end steamer, which costs $11,000, and has an estimated useful life of 6 years with an estimated salvage value of $1,100. This steamer falls into the MACRS 5-years class, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The new steamer is faster and would allow for an output expansion, so sales would rise by $2,000 per year; even so, the new machine's much greater efficiency would reduce operating expenses by $1,600 per year. To support the greater sales, the new machine would require that inventories increase by $2,900, but accounts payable would simultaneously increase by $700. Gilbert's marginal federal-plus-state tax rate is 40%, and its WACC is 15%. Should it replace the old steamer?

The old steamer

be replaced.

What is the NPV of the project? Round your answer to the nearest dollar.

Answer 1

Calculation of Net Present value is as follows:

Intitial Cash Outlay for the project:

= Sale value of old steamer after tax - Cost of New steamer - Investment in working capital

Cost of new steamer = $11,000

Sale value of old steamer after tax = Sale Value - (Profit on Sale)* Tax rate

4150 - (4150 - 3575)*40% = $3920

Investment in working Capital = Increase in Inventory - increase in payables

= 2900 - 700 = $2200

Intitial Cash Outlay for the project as per the above discussed formula

= 3920 - 11000 - 2200

= $ -9,280

Now we can Calculate the Present Value in the Excel Sheet as below:

Formulas used in Excel Sheet are

So, the Net Present Value of the machines come out to be $ 2,032.39, So the old Steamer can be replaced.

* Incremental Depreciation for the period is calculated as below :

Incremental Depreciation	1	2	3	4	5	6
Cost of New Steamer	11,000	11,000	11,000	11,000	11,000	11,000
MACRS 5 year depreciation rate	20%	32%	19.20%	11.52%	11.52%	5.76%
New Depreciation	2200	3520	2112	1267.2	1267.2	633.6
Old Depreciation	650	650	650	650	650	325
Change in Depreciation	1550	2870	1462	617.2	617.2	308.6

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