Question

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 $305 for the sixth year. Its current book value is $3,555, and it can be sold on an Internet auction site for $4,115 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 $12,000, and has an estimated useful life of 6 years with an estimated salvage value of $1,600. 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 allows for an output expansion, so sales would rise by $2,000 per year; the new machine's much greater efficiency would reduce operating expenses by $1,400 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 25%, and the project cost of capital is 15%.

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

$  

Should it replace the old steamer?

The old steamer -Select-shouldshould notItem 2 be replaced

Answer 1

1. NPV of the Project = $159.13

2. Old Steamer should be Replaced since NPV of the project is positive

Calculation of Net Present value of Replacement Project
Particulars	Year (n)
0	1	2	3	4	5	6
Initial Investment
Purchase of Side Steamer (A)	-12000
Sale value of Wood Steamer (B)	3975
Net Investment (C = A+B)	-8025
Operating Cashflows
Sales Increase (D)		2000	2000	2000	2000	2000	2000
Reduction in operating expense (E )		1400	1400	1400	1400	1400	1400
Total Incremental Cashflows (F = D+E)		3400	3400	3400	3400	3400	3400
Incremental Depreciation (G) (See Note 1 below)		1750	3190	1654	732.4	732.4	386.2
Profit Before Tax (H = F-G)		1650	210	1746	2667.6	2667.6	3013.8
Less: Tax @25% (I = H*25%)		412.5	52.5	436.5	666.9	666.9	753.45
Profit After Tax (J = H-I)		1237.5	157.5	1309.5	2000.7	2000.7	2260.35
Addback Depreciation (K = G)		1750	3190	1654	732.4	732.4	386.2
Net Operating Cashflows After Tax (L = J+K)		2987.5	3347.5	2963.5	2733.1	2733.1	2646.55
Investment in Working Capital
Increase in Inventories (M)	-2900
Increase in Accounts Payable (N)	700
Net Investment in Working Capital (O = M+N)	-2200
Salvage Value
Net Salvage Value (see Note 2 below) (P)							600
Total Cashflows (Q = C+L+O+P)	-10225	2987.5	3347.5	2963.5	2733.1	2733.1	3246.55
Discounting Factor @15% (R ) 1/(1+15%)^n n=0,1,2,3,4,5,6	1	0.869565	0.756144	0.657516	0.571753	0.497177	0.432328
Discounted Cashflows	-10225	2597.826	2531.191	1948.549	1562.659	1358.834	1403.573
Net Present Value	1177.63

Note 1:
Calculation of Incremental Depreciation
Particulars	1	2	3	4	5	6
Side Steamer Depreciation ($12,000 * 20%,32%,19.2%,11.52%,11.52%,5.76%	2400	3840	2304	1382.4	1382.4	691.2
Wood Steamer Depreciation	650	650	650	650	650	305
Incremental Depreciation	1750	3190	1654	732.4	732.4	386.2

Note 2:
Calculation of Incremental Salvage Value
Particulars	Year 6
Salvage value of Side Steamer (A)	1600
Salvage value of Wood Steamer (B)	800
Incremental Salvage Value (C = A-B)	800
Tax @25% (D = C*25%)	200
Net Cashflow from salvage value (E = C-D)	600

Note 3:
Calculation of Net Sale Value of Wood Steamer
Particulars	Amount
Sale value (A)	4115
Book Value (B)	3555
Profit on sale (C )	560
Tax on sale (D = C*25%)	140
After tax sale value (E = A-D)	3975