Question

Replacement Analysis St. Johns River Shipyards' 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. The new welder will cost $180,500 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 $28,000 to $67,000 per year. The new machine will be depreciated over its 5-year MACRS recovery period, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The applicable corporate tax rate is 40%, and the project cost of capital is 14%. Should the old welder be replaced by the new one? Do not round intermediate calculations. Round your answer to the nearest cent. Negative value, if any, should be indicated by a minus sign. The NPV of the project is $   Old welder -Select-shouldshould notItem 2 be replaced.

Answer 1

Increase in earnings before depreciation	67000-28000	$39,000
Calculate NPV of the project as shown below
Year	0	1	2	3	4	5	6	7	8
Increase in earnings before depreciation		$39,000.00	$39,000.00	$39,000.00	$39,000.00	$39,000.00	$39,000.00	$39,000.00	$39,000.00
Less: Depreciation		-$36,100.00	-$57,760.00	-$34,656.00	-$20,793.60	-$20,793.60	-$10,396.80
Income before taxes	$0	$2,900.00	-$18,760.00	$4,344.00	$18,206.40	$18,206.40	$28,603.20	$39,000.00	$39,000.00
Less: Taxes @ 40%		-$1,160.00	$7,504.00	-$1,737.60	-$7,282.56	-$7,282.56	-$11,441.28	-$15,600.00	-$15,600.00
Net income		$1,740.00	-$11,256.00	$2,606.40	$10,923.84	$10,923.84	$17,161.92	$23,400.00	$23,400.00
Add: Depreciation		$36,100.00	$57,760.00	$34,656.00	$20,793.60	$20,793.60	$10,396.80	$0.00	$0.00
Purchase cost of new welder	-$180,500
Net cash flow	-$180,500	$37,840.00	$46,504.00	$37,262.40	$31,717.44	$31,717.44	$27,558.72	$23,400.00	$23,400.00
Discount factor @ 14%	1	0.87719298	0.76946753	0.67497152	0.59208028	0.51936866	0.45558655	0.39963732	0.35055905
	1/(1.14^0)	1/(1.14^1)	1/(1.14^2)	1/(1.14^3)	1/(1.14^4)	1/(1.14^5)	1/(1.14^6)	1/(1.14^7)	1/(1.14^8)
Present value (Net cash flow*Discount factor)	-$180,500.00	$33,192.98	$35,783.32	$25,151.06	$18,779.27	$16,473.04	$12,555.38	$9,351.51	$8,203.08
Net present value	-$21,010.35
Thus, net present value is -$21,010.35
Old welder should not be replaced as NPV is negative
Calculation of depreciation
Year
1	$36,100.00	180500*20%
2	$57,760.00	180500*32%
3	$34,656.00	180500*19.20%
4	$20,793.60	180500*11.52%
5	$20,793.60	180500*11.52%
6	$10,396.80	180500*5.76%