Question

The Woodruff Corporation purchased a piece of equipment three years ago for $248,000. It has an asset depreciation range (ADR) midpoint of eight years. The old equipment can be sold for $93,250.

A new piece of equipment can be purchased for $324,000. 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............... $81,500 $24,000 2............... 76,000 14,000 3............... 70,000 9,250 4............... 60,000 6,250 5............... 52,000 6,500 6............... 44,500 -6,250

The firm has a 25 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

A. Calculation New cost of New Equipment

Particulars	Amount ($)
Purchase price of new equipment	3,24,000
Less- selling price of old equipment	(93,250)
Net purchase cost of new equipment	2,30,750

B.Calculation of present value of increment benefit

Net income of New Equipment

Year	Operating gain/loss	Tax @ 25%	Net operating gain/loss
1	81,500	20,375	61,125
2	76,000	19,000	57,000
3	70,000	17,500	52,500
4	60,000	15,000	45,000
5	52,000	13,000	39,000
6	44,500	11,125	33,375

Net income of old equipment

Year	Operating gain/loss	Tax @25%	Net Operating gain/loss
1	24,000	6,000	18,000
2	14,000	3,500	10,500
3	9,250	2,312.5	6,937.5
4	6,250	1,562.5	4,687.5
5	6,500	1,625	4,875
6	(6,250)	1,562.5	(4,687.5)

Year	Net operating gain/loss of new equipment	Net operating gain/loss of old equipment	Incremental net operating gain/loss	PVF @9%	PV
1	61,125	18,000	43,125	0.9174	39,562.88
2	57,000	10,500	46,500	0.8417	39,139.05
3	52,500	6,937.5	45,562.5	0.7722	35,183.36
4	45,000	4,687.5	40,312.5	0.7084	28,557.38
5	39,000	4,875	34,125	0.6499	22,177.84
6	33,375	(4,687.5)	38,062.5	0.5963	22,696.37
					1,87,316.88

C. NPV of Replacement Decision -

= Total Present Value -  Net Purchase cost of new equipment

=1,87,316.88 - 2,30,750

=(43,433.12)

NPV is negative. Hence, the project should not be accepted.