Question

The Woodruff Corporation purchased a piece of equipment three years ago for $229,000. It has an asset depreciation range (ADR) midpoint of eight years. The old equipment can be sold for $86,000.

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............... $82,000 $24,250 2............... 75,750 15,750 3............... 69,000 7,250 4............... 59,500 6,250 5............... 51,250 7,500 6............... 45,500 -6,500

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) Net cost of the new equipment:

Cost of new equipment purchased = $ 315500

Annual depreciation of old equipment = $ 229000/8 years = $ 28625

Net book value of the old equipment = $ 229000 - $ 28625*3 = $ 143125

Sale value of assets = $86000

Loss on sale of fixed assets = $57125

Loss on sale of fixed assets (After tax shield) = $57125*0.75

=$ 42843.75

Net cost of new equipment = $315500+$42843.75

= $ 358343.75

(b) Calculation of present value of incremental benefits:

Years	New Equipment	Old Equipment	Incremental Cash Inflow
Operating income	Operating income (After tax)	Depreciation	Cash inflows	Operating income	Operating income (After tax)	Depreciation	Cash inflows
1	82000	61500	39437.5	100937.5	24250	18187.5	28625	46812.5	54125
2	75750	56812.5	39437.5	96250	15750	11812.5	28625	40437.5	55812.5
3	69000	51750	39437.5	91187.5	7250	5437.5	28625	34062.5	57125
4	59500	44625	39437.5	84062.5	6250	4687.5	28625	33312.5	50750
5	51250	38437.5	39437.5	77875	7500	5625	28625	34250	43625
6	45500	34125	39437.5	73562.5	-6500	-4875	0	-4875	78437.5

PV of Incremental Cash flows = 54125/1.09+55812.5/(1.09)2+57125/(1.09)3+50750/(1.09)4+43625/(1.09)5+78437.5/(1.09)6

= $49655.96+$46976.26+$44110.98+$35952.58+$28353.26+$46769.72

= $251818.76

(c) NPV of the new equipment the replacement decision:

= $ 251818.76 - $ 358343.75

= $ 106524.99