In: Finance
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 $160,000, including installation costs. During its 5-year life, it will reduce cash operating expenses by $45,000 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%.
CF1 | $ |
CF2 | $ |
CF3 | $ |
CF4 | $ |
CF5 | $ |
Book value old machine= (purchase price)*remaining life/total life | |
= (100000)*5/10 | |
= 50000 |
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 | -160000 | ||||||
=a. Initial Investment outlay | -110000 | ||||||
3 years MACR rate | 33.33% | 44.45% | 14.81% | 7.41% | 0.00% | ||
Savings | 45000 | 45000 | 45000 | 45000 | 45000 | ||
-Depreciation | =Cost of machine*MACR% | -53328 | -71120 | -23696 | -11856 | 0 | |
=Pretax cash flows | -8328 | -26120 | 21304 | 33144 | 45000 | ||
-taxes | =(Pretax cash flows)*(1-tax) | -5413.2 | -16978 | 13847.6 | 21543.6 | 29250 | |
+Depreciation | 53328 | 71120 | 23696 | 11856 | 0 | ||
=after tax operating cash flow | 47914.8 | 54142 | 37543.6 | 33399.6 | 29250 | ||
+Tax shield on salvage book value | =Salvage value * tax rate | 0 | |||||
=Terminal year after tax cash flows | 0 | ||||||
b - f. Total Cash flow for the period | -110000 | 47915 | 54142 | 37544 | 33400 | 29250 | |
Discount factor= | (1+discount rate)^corresponding period | 1 | 1.14 | 1.2996 | 1.481544 | 1.6889602 | 1.9254146 |
Discounted CF= | Cashflow/discount factor | -110000 | 42030.52632 | 41660.511 | 25340.861 | 19775.244 | 15191.533 |
g. NPV= | Sum of discounted CF= | 33999 |
Accept new machine