Question

St. Johns River Shipyards is considering the replacement of an 8-year-old riveting machine with a new one that will increase earnings before depreciation from $30,000 to $44,000 per year. The new machine will cost $82,500, and it will have an estimated life of 8 years and no salvage value. The new riveting machine is eligible for 100% bonus depreciation at the time of purchase. The applicable corporate tax rate is 25%, and the firm's WACC is 14%. The old machine has been fully depreciated and has no salvage value.

What is the NPV of the project? Negative value, if any, should be indicated by a minus sign. Round your answer to the nearest cent.
$  

Should the old riveting machine be replaced by the new one?
-Select-YesNo

Answer 1

Answer :-

Net Present value = $91207.51

Old Machine is not replaced

..

Explanations :-

.

a) NPV

NPV is the difference between the present value of cash inflows and cash outflows. The basic formula for calculating NPV is given below:

NPV = Cash Flow Year 0 + Cash Flow Year 1/(1+Required Return)^1 + Cash Flow Year 2/(1+Required Return)^2 + Cash Flow Year 3/(1+Required Return)^3 + Cash Flow Year 4/(1+Required Return)^4 + Cash Flow Year 5(1+Required Return)^5 + Cash Flow Year 6/(1+Required Return)^6 + Cash Flow Year 7/(1+Required Return)^7 + Cash Flow Year 8/(1+Required Return)^8

Net Cash inflow = after tax Earnings + Depreciation tax Shield

Earnings After Tax = $44,000 × (1-.025)

  = $44,000 × 0.75

= $33,000

as per the question ,, depreciation is 100% bonus depreciation, the full amount of machinary is depreciated at the time of purchase, so the inetaial cash outflow is the after tax amount of fully depreciatd machinary

Initial cash outflow = $82,500 × 0.75

= $61875

earnings after tax = $33,000

WACC = 14%

Present Value of Annuity Factor @14% for 8 years = 4.63886

Present value of cash inflow = $33,000 × 4.63886

= $153,082.50849

Net Present value = Present value of cash inflow - Initial investment

   = $153,082.51 - $61875

Net Present value = $91207.51

..

b) NPV generated from Old equipment

Earnings After Tax = $30,000 × (1-.025)

  = $30,000 × 0.75

= $22,500

WACC = 14%

Present Value of Annuity Factor @14% for 8 years = 4.63886

Present value of cash inflow = $22,500 × 4.63886

= $104,374.35

Net Present value = Present value of cash inflow - Initial investment

   = $104,374.35 - 0

Net Present value = $104,374.35

Net Present value of Old Machine is higher than new machine, so machine is not replaced