Question

Replacement Analysis

The Everly Equipment Company's flange-lipping machine was purchased 5 years ago for $100,000. It had an expected life of 10 years when it was bought and is being depreciated by the straight-line method by $10,000 per year. As the older flange-lippers are robust and useful machines, this one can be sold for $20,000 at the end of its useful life.

A new high-efficiency, digital-controlled flange-lipper can be purchased for $160,000, including installation costs. During its 5-year life, it will reduce cash operating expenses by $55,000 per year, although it will not affect sales. At the end of its useful life, the high-efficiency machine is estimated to be worthless. MACRS depreciation will be used, and the machine will be depreciated over its 3-year class life rather than its 5-year economic life, so the applicable depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%.

The old machine can be sold today for $55,000. The firm's tax rate is 35%, and the appropriate WACC is 14%.

1. If the new flange-lipper is purchased, what is the amount of the initial cash flow at Year 0? Round your answer to the nearest whole dollar. Enter negative answers with minus sign.
   $   
2. 
   
3. 
   
4. 
   
5. What are the incremental net cash flows that will occur at the end of Years 1 through 5? Round your answers to the nearest whole dollar.

   CF1	$
   CF2	$
   CF3	$
   CF4	$
   CF5	$

6. 
   
7. What is the NPV of this project? Round your answer to the nearest whole dollar.
   $   

Answer 1

Ans.

	Formulas used	0	1	2	3	4	5
Proceeds from sale of existing asset	selling price* ( 1 - tax rate)	$       35,750.00
Tax shield on existing asset book value	Book value * tax rate	$       17,500.00
Cost of new machine		$   (160,000.00)
a. Initial Investment outlay		$   (106,750.00)
3 years MACR rate			33.33%	44.45%	14.81%	7.41%
Savings			$      55,000.00	$ 55,000.00	$ 55,000.00	$ 55,000.00	$ 55,000.00
Less: Depreciation	Cost of machine*MACR%	$    (53,328.00)	$ (71,120.00)	$ (23,696.00)	$ (11,856.00)	$               -
Pretax cash flows			$        1,672.00	$ (16,120.00)	$ 31,304.00	$ 43,144.00	$ 55,000.00
After Tax Cash Flows	(Pretax cash flows)*(1- tax (35%))	$        1,086.80	$ (10,478.00)	$ 20,347.60	$ 28,043.60	$ 35,750.00
Add: Depreciation			$      53,328.00	$ 71,120.00	$ 23,696.00	$ 11,856.00	$               -
After tax operating cash flow			$      54,414.80	$ 60,642.00	$ 44,043.60	$ 39,899.60	$ 35,750.00
b. Total Cash flow for the period		$   (106,750.00)	$     54,414.80	$ 60,642.00	$ 44,043.60	$ 39,899.60	$ 35,750.00
Discount factor @ 14%		1	0.877192982	0.769467528	0.674971516	0.592080277	0.519368664
Present Value		$   (106,750.00)	$      47,732.28	$ 46,662.05	$ 29,728.18	$ 23,623.77	$ 18,567.43
c. NPV=	Sum of discounted CF=	$      59,563.70