Question

Problem 11-13
Replacement Analysis

The Everly Equipment Company's flange-lipping machine was purchased 5 years ago for $100,000. It had an expected life of 10 years when it was bought and its remaining depreciation is $10,000 per year for each year of its remaining life. As older flange-lippers are robust and useful machines, this one 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 $150,000, 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 cost of capital is 14%.

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? Do not round intermediate calculations. Round your answers to the nearest whole dollar.

   CF1	$
   CF2	$
   CF3	$
   CF4	$
   CF5	$

6. 
   
7. What is the NPV of this project? Do not round intermediate calculations. Round your answer to the nearest whole dollar.
   $
   
   Should Everly replace the flange-lipper?
       -Select-YesNoItem 8

Answer 1

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	17500
Cost of new machine		-150000
= a. Initial Investment outlay		-100000
3 years MACR rate			33.33%	44.45%	14.81%	7.41%	0.0000%
Savings			55000	55000	55000	55000	55000
-Depreciation	=Cost of machine*MACR%		-49995	-66675	-22215	-11115	0
=Pretax cash flows			5005	-11675	32785	43885	55000
-taxes	=(Pretax cash flows)*(1-tax)		3253.25	-7588.75	21310.25	28525.25	35750
+Depreciation			49995	66675	22215	11115	0
=after tax operating cash flow			53248.25	59086.25	43525.25	39640.25	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		-100000	53248.25	59086.25	43525.25	39640.25	35750
Discount factor=	(1+discount rate)^corresponding period	1	1.14	1.2996	1.481544	1.6889602	1.9254146
Discounted CF=	Cashflow/discount factor	-100000	b. 46708.991	c. 45464.9508	d. 29378.304	e. 23470.21	f.18567.43
g. NPV=	Sum of discounted CF=	63589.8859

Buy new equipment as NPV is positive