Question

St. Johns River Shipyard’s 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. A new welder will cost $182,500 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 $27,000 to $74,000 per year. The new machine will be depreciated over its 5-year MACRSrecoveryperiod,sotheapplicabledepreciationratesare20.00%,32.00%,19.20%, 11.52%,11.52%, and5.76%.Theapplicablecorporatetax rateis40%, and the project cost of capital is 12%. Should the old welder be replaced by the new one?

Answer 1

Year	Incremental earning	Less: Dep			Before tax income	Less: tax	After tax Income	Add: Dep	Annual cash flows	PVf at 12%	Present Value of Cf
1	47,000		36,500	(182500*20%)	10,500		4200	6,300	36,500	42,800	0.892857	38214.29
2	47,000		58400	(182500*32%)	-11,400		0	-11,400	58,400	47,000	0.797194	37468.11
3	47,000		35,040	(182500*19.20%)	11,960		4784	7,176	35,040	42,216	0.71178	30048.51
4	47,000		21,024	(182500*11.52%)	25,976		10390	15,586	21,024	36,610	0.635518	23266.32
5	47,000		21,024	(182500*11.52%)	25,976		10390	15,586	21,024	36,610	0.567427	20773.5
6	47,000		10,512	(182500*5.76%)	36,488		14595	21,893	10,512	32,405	0.506631	16417.38
7	47,000		0			47,000		18800	28,200	0	28,200	0.452349	12756.25
8	47,000		0			47,000		18800	28,200	0	28,200	0.403883	11389.51
										Present value of inflows	190334
										Less: Investment		182500
										Net present values		7834