Question

The Woodruff Corporation purchased a piece of equipment three years ago for $228,000. It has an asset depreciation range (ADR) midpoint of eight years. The old equipment can be sold for $91,500.

A new piece of equipment can be purchased for $315,500. It also has an ADR of eight years.

Assume the old and new equipment would provide the following operating gains (or losses) over the next six years:

Year New Equipment Old Equipment 1............... $79,750 $25,250 2............... 77,000 16,500 3............... 70,750 8,000 4............... 59,000 6,250 5............... 50,750 4,750 6............... 44,000 -6,250

The firm has a 36 percent tax rate and a 9 percent cost of capital.

What is the net cost of the new equipment? Round your solution to two decimal places.

What is the present value of incremental benefits? Round your solution to two decimal places.

What is the NPV of this replacement decision? Round your solution to two decimal places.

Answer 1

Calculation of Net Cost of New Equipment

	$
Cost of the new Equipment	3,15,500
Less: Scrap Value of old Equipment	91,500
Net Cost of the New Equipment	2,24,000

Calculation of Depreciation of New Machine = $315500 / 6 Years = $52,583.33 per year

Calculation of Depreciation of Old Machine = $228000 / 6 Years = $38,000 per year

Therefore, Incremental Depreciation = $52,583.33 - $38,000 = $14,583.33

Calculation of Net Present Value

	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Operating Gains of New Machine	79,750.00	77,000.00	70,750.00	59,000.00	50,750.00	44,000.00
Operating Gains of Old Machine	25,250.00	16,500.00	8,000.00	6,250.00	4,750.00	-6,250.00
Incremental Operating gains	54,500.00	60,500.00	62,750.00	52,750.00	46,000.00	50,250.00
Less: Incremental Depreciation	14,583.33	14,583.33	14,583.33	14,583.33	14,583.33	14,583.33
Incremental Gains Before Tax	39,916.67	45,916.67	48,166.67	38,166.67	31,416.67	35,666.67
Less: Tax @ 36%	14,370.00	16,530.00	17,340.00	13,740.00	11,310.00	12,840.00
Net gains after tax	25,546.67	29,386.67	30,826.67	24,426.67	20,106.67	22,826.67
Incremental Cash inflows from new machine = Incremental gains after tax + incremental Depreciation	40,130.00	43,970.00	45,410.00	39,010.00	34,690.00	37,410.00
Present value Factor @ 9%	0.9174	0.8417	0.7722	0.7084	0.6499	0.5963
Present value of Incremental Benefits	36,816.51	37,008.67	35,064.85	27,635.67	22,546.12	22,306.36
Total Present value of Incremental Benefits	1,81,378.18
Less: Net Cost of the new equipment	2,24,000.00
Net Present Value of the replacement decision	-42,621.82

Summary	$
Net Cost of the New Equipment	2,24,000
Present value of Incremental Benefits	1,81,378
Net Present Value of the replacement decision	-42,622