Question

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 $82,500 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 $29,000 to $58,000 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 not be replaced.

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

Answer 1

We have to calculate incremental cash flow from the new machine
Incremental earnings before depreciation (58,000-29,000)					29000
The depreciation under old welding machine is zero, therefore the depreciation on new welding machine would be incremental depreciation
Year	Depreciation Rate	Depreciation amount
1	20%	16500
2	32%	26400
3	19.20%	15840
4	11.52%	9504
5	11.52%	9504
6	5.76%	4752
Calculation of NPV of incremental cash flow
Net present value = present value of cash outflow plus present value of cash inflow
Year	0	1	2	3	4	5	6	7	8
Cost of welder	-$82,500.00
Earnings before depreciation		$29,000.00	$29,000.00	$29,000.00	$29,000.00	$29,000.00	$29,000.00	$29,000.00	$29,000.00
Less: Depreciation		$16,500.00	$26,400.00	$15,840.00	$9,504.00	$9,504.00	$4,752.00	$0.00	$0.00
Earnings before tax		$12,500.00	$2,600.00	$13,160.00	$19,496.00	$19,496.00	$24,248.00	$29,000.00	$29,000.00
Less: Tax @ 40%		$5,000.00	$1,040.00	$5,264.00	$7,798.40	$7,798.40	$9,699.20	$11,600.00	$11,600.00
Earnings after tax		$7,500.00	$1,560.00	$7,896.00	$11,697.60	$11,697.60	$14,548.80	$17,400.00	$17,400.00
Add: Depreciation		$16,500.00	$26,400.00	$15,840.00	$9,504.00	$9,504.00	$4,752.00	$0.00	$0.00
Free cash flow		$24,000.00	$27,960.00	$23,736.00	$21,201.60	$21,201.60	$19,300.80	$17,400.00	$17,400.00
Discount factor @ 11%	1.00000	0.90090	0.81162	0.73119	0.65873	0.59345	0.53464	0.48166	0.43393
Cash flow	-$82,500.00	$21,621.62	$22,692.96	$17,355.56	$13,966.15	$12,582.12	$10,319.00	$8,380.86	$7,550.32
Net present value	$31,968.59
Since the incremental net present value is positive, the old welder should be replaced by the new one.
Calculation of NPV of project
Year	0	1	2	3	4	5	6	7	8
Cost of welder	-$82,500.00
Earnings before depreciation		$58,000.00	$58,000.00	$58,000.00	$58,000.00	$58,000.00	$58,000.00	$58,000.00	$58,000.00
Less: Depreciation		$16,500.00	$26,400.00	$15,840.00	$9,504.00	$9,504.00	$4,752.00	$0.00	$0.00
Earnings before tax		$41,500.00	$31,600.00	$42,160.00	$48,496.00	$48,496.00	$53,248.00	$58,000.00	$58,000.00
Less: Tax @ 40%		$16,600.00	$12,640.00	$16,864.00	$19,398.40	$19,398.40	$21,299.20	$23,200.00	$23,200.00
Earnings after tax		$24,900.00	$18,960.00	$25,296.00	$29,097.60	$29,097.60	$31,948.80	$34,800.00	$34,800.00
Add: Depreciation		$16,500.00	$26,400.00	$15,840.00	$9,504.00	$9,504.00	$4,752.00	$0.00	$0.00
Free cash flow		$41,400.00	$45,360.00	$41,136.00	$38,601.60	$38,601.60	$36,700.80	$34,800.00	$34,800.00
Discount factor @ 11%	1.00000	0.90090	0.81162	0.73119	0.65873	0.59345	0.53464	0.48166	0.43393
Cash flow	-$82,500.00	$37,297.30	$36,815.19	$30,078.29	$25,428.07	$22,908.17	$19,621.75	$16,761.71	$15,100.64
Net present value	$121,511.12
The NPV of the project is $121,511.12