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 $400 for 6 years. Its current book value is $2,400, and it can be sold on an Internet auction site for $4,500 at this time. Thus, the annual depreciation expense is $2,400/6=$400 per year. 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 $8,200, and has an estimated useful life of 6 years with an estimated salvage value of $900. 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 $1,600 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 the project cost of capital is 16%.

Should it replace the old steamer?

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

Answer 1

Purchase Price	$                       8,200
Sale of Old Machine	$                     (4,500)
Tax on Sale of Old Machine	$                           840
Change Working Capital	$                       2,200
Net Investment	$                       6,740

Book Value Of Old Machine	$        2,400
Sale Price	$        4,500
Gain on Sale	$        2,100
Tax on Sale(2100*40%)	$           840

Change Working Capital
inventories increase	$        2,900
accounts payable incresae	$           700
Change Working Capital	$        2,200

Annual Cashflows:
Sales Increase	$                       2,000
Cost Decrease	$                       1,600
Increase in pre Tax Revenue	$                       3,600
Tax Rate	40%
Increase in Post Tax Revenue	$                       2,160

Calculation of Tax Shield on Depreciation
Year	1	2	3	4	5	6
New Machine	$ 1,640.00	$ 2,624.00	$ 1,574.40	$ 944.64	$ 944.64	$ 472.32
Old Machine	$     400.00	$     400.00	$     400.00	$ 400.00	$ 400.00	$ 400.00
Change	$ 1,240.00	$ 2,224.00	$ 1,174.40	$ 544.64	$ 544.64	$     72.32
Tax Rate	40%	40%	40%	40%	40%	40%
Tax Shield	$     496.00	$     889.60	$     469.76	$ 217.86	$ 217.86	$     28.93

Calculation of PV of Inflows
Year	Increase in pre-tax revenue	Tax Shield on Depreciation	Total Inflow	PV Factor	Present Value
1	$        2,160	$                496	$              2,656	0.86207	$        2,290
2	$        2,160	$                890	$              3,050	0.74316	$        2,266
3	$        2,160	$                470	$              2,630	0.64066	$        1,685
4	$        2,160	$                218	$              2,378	0.55229	$        1,313
5	$        2,160	$                218	$              2,378	0.47611	$        1,132
6	$        2,160	$                  29	$              2,189	0.41044	$           898
	PV of Inflows				$        9,585

PV of Inflows		$    9,585
PV of Salvage Value	900*0.41044	$        369
Working Capital recovery	2200*0.41044	$        903
PV of Tax on Salvage Value of Old Machine	(900*.4)*0.41044	$      (148)
Opportunity Cost of Old Machine(800*0.6)	800*0.6*0.41044	$      (197)
Investment		$ (6,740)
Net Present Value		$    3,772

Since the NPV is positive, the project should be accepted.

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