Question

eBook Replacement Analysis DeYoung Entertainment Enterprises is considering replacing the latex molding machine it uses to fabricate rubber chickens with a newer, more efficient model. The old machine has a book value of $450,000 and a remaining useful life of 5 years. The current machine would be worn out and worthless in 5 years, but DeYoung can sell it now to a Halloween mask manufacturer for $135,000. The old machine is being depreciated by $90,000 per year for each year of its remaining life. If DeYoung doesn't replace the old machine, it will have no salvage value at the end of its useful life. The new machine has a purchase price of $775,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $105,000. The applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. Being highly efficient, it is expected to economize on electric power usage, labor, and repair costs, and, most importantly, to reduce the number of defective chickens. In total, an annual savings of $205,000 will be realized if the new machine is installed. The company's marginal tax rate is 25% and the project cost of capital is 15%. What is the initial net cash flow if the new machine is purchased and the old one is replaced? Round your answer to the nearest dollar. Cash outflow, if any, should be indicated by a minus sign. $   What is the incremental depreciation tax shield (i.e., the change taxes due to the change in depreciation expenses) if the replacement is made? (Hint: First calculate the annual depreciation expense for the new machine and compare it to the depreciation on the old machine.) Do not round intermediate calculations. Round your answers to the nearest dollar. Negative values, if any, should be indicated by a minus sign. Year Incremental depreciation tax shield 1 $   2 $   3 $   4 $   5 $   What is the after-tax salvage value at Year 5? Do not round intermediate calculations. Round your answer to the nearest dollar. Negative value, if any, should be indicated by a minus sign. $   What are the total incremental project cash flows in Years 0 through 5? What is the NPV? Do not round intermediate calculations. Round your answers to the nearest dollar. Negative values, if any, should be indicated by a minus sign. CF0 $   CF1 $   CF2 $   CF3 $   CF4 $   CF5 $   NPV $

Answer 1

a]	Purchase price of the new machine		$      -7,75,000
	Sale value of old machine	$      1,35,000
	Book value of old machine	$      4,50,000
	Loss on sale = 450000-135000 =	$      3,15,000
	Tax shield on loss at 25%	$         78,750
	After tax sale value = 135000+78750 =		$        2,13,750
	Initial net cash flow		$ -5,61,250
b]		0	1	2	3	4	5
	Depreciation of the new machine		$ 1,55,000	$      2,48,000	$ 1,48,800	$         89,280	$             89,280
	Depreciation of the old machine		$            90,000	$         90,000	$         90,000	$         90,000	$             90,000
	Incremental depreciation		$            65,000	$      1,58,000	$         58,800	$             -720	$                 -720
	Tax shield at 25%		$            16,250	$         39,500	$         14,700	$             -180	$                 -180
c]	Salvage value of new machine at EOY 5		$ 1,05,000
	Book value = 775000*5.76% =		$            44,640
	Gain on sale		$            60,360
	Tax on sale at 25%		$ -15,090
	After tax salvage value		$            89,910
d]	After tax annual savings [205000*(1-25%)]		$ 1,53,750	$      1,53,750	$ 1,53,750	$ 1,53,750	$ 1,53,750
	Tax shield on incremental depreciation		$            16,250	$         39,500	$         14,700	$             -180	$                 -180
	After tax salvage value at EOY 5						$             89,910
	Total incremental project cash flows	$ -5,61,250	$ 1,70,000	$      1,93,250	$ 1,68,450	$ 1,53,570	$ 2,43,480
	PVIF at 15% [PVIF = 1/1.15^t]	1	0.86957	0.75614	0.65752	0.57175	0.49718
	PV at 15%	$ -5,61,250	$        1,47,826	$      1,46,125	$     1,10,759	$         87,804	$ 1,21,053
	NPV	$         52,316