Question

The Everly Equipment Company's flange-lipping machine was purchased 5 years ago for $90,000. It had an expected life of 10 years when it was bought and is being depreciated by the straight-line method by $9,000 per year. As the older flange-lippers are robust and useful machines, it can be sold for $20,000 at the end of its useful life.

A new high-efficiency digital-controlled flange-lipper can be purchased for $130,000, including installation costs. During its 5-year life, it will reduce cash operating expenses by $55,000 per year, although it will not affect sales. At the end of its useful life, the high-efficiency machine is estimated to be worthless. MACRS depreciation will be used, and the machine will be depreciated over its 3-year class life rather than its 5-year economic life, so the applicable depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%.

The old machine can be sold today for $50,000. The firm's tax rate is 35%, and the appropriate WACC is 15%.

1. If the new flange-lipper is purchased, what is the amount of the initial cash flow at Year 0? Round your answer to the nearest whole dollar.
   $  
2. 
   
3. 
   
4. 
   
5. What are the incremental net cash flows that will occur at the end of Years 1 through 5? Round your answers to the nearest whole dollar.

   CF1	$
   CF2	$
   CF3	$
   CF4	$
   CF5	$

6. 
   
7. What is the NPV of this project? Round your answer to the nearest whole dollar.
   $   
   
   Should Everly replace the flange-lipper?
     

Answer 1

Book value of old equipment

Book value = (purchase price)*remaining life/total life
= (90000)*5/10
= 45000

Time line		0	1	2	3	4	5
Proceeds from sale of existing asset	=selling price* ( 1 -tax rate)	32500
Tax shield on existing asset book value	=Book value * tax rate	15750
Cost of new machine		-130000
=Initial Investment outlay a.		-81750
3 years MACR rate			33.33%	44.45%	14.81%	7.41%	0.00%
Savings			55000	55000	55000	55000	55000
-Depreciation	=Cost of machine*MACR%		-43329	-57785	-19253	-9633	0
=Pretax cash flows			11671	-2785	35747	45367	55000
-taxes	=(Pretax cash flows)*(1-tax)		7586.15	-1810.25	23235.55	29488.55	35750
+Depreciation			43329	57785	19253	9633	0
=after tax operating cash flow b.			50915	55975	42489	39122	35750
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							0
Total Cash flow for the period		-81750	50915.15	55974.75	42488.55	39121.55	35750
Discount factor=	(1+discount rate)^corresponding period	1	1.15	1.3225	1.520875	1.7490063	2.0113572
Discounted CF=	Cashflow/discount factor	-81750	44274.043	42324.9527	27936.911	22367.873	17774.068
c. NPV=	Sum of discounted CF=	72928