Question

The Everly Equipment Company's flange-lipping machine was purchased 5 years ago for $50,000. It had an expected life of 10 years when it was bought and its remaining depreciation is $5,000 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 $130,000, including installation costs. During its 5-year life, it will reduce cash operating expenses by $40,000 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 25%, and the appropriate cost of capital is 13%. a. If the new flange-lipper is purchased, what is the amount of the initial cash flow at Year O? Round your answer to the nearest dollar. Cash outflow, if any, should be indicated by a minus sign. b. 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 dollar. Cash outflows, if any, should be indicated by a minus sign. CF1 to CF2 to A A A c. What is the NPV of this project? Do not round intermediate calculations. Round your answer to the nearest whole dollar. Negative value, if any, should be indicated by a minus sign. Should Everly replace the flange-lipper? -Select-

Answer 1

Part a)

Purchase price of new machine-(Sale price of old machine-tax on the profit from dale of old machine)

CF=

130000-(50000-Tax rate x (Sale price - Book value))

CF=

130000-(50000-0.25x (50000- (Cost -remaining life x annual depreciation)))

CF=

130000-(50000-0.25x (50000-(50000- 5x5000))

CF=

130000-(50000-0.25x (25000)

CF=

CF=
130000-43750

CF=
86250

Part b)

Depreciation schedule:

Year	Depreciation rate	Depreciation
1.00	33.33%	$       43,329.00
2.00	44.45%	$       57,785.00
3.00	14.81%	$       19,253.00
4.00	7.41%	$          9,633.00

So CF 1 - 5 =

Particulars	Remark	1	2	3	4	5
Costsavings	Given	$       40,000.00	$       40,000.00	$       40,000.00	$       40,000.00	$       40,000.00
Depreciation	MACRS	$       43,329.00	$       57,785.00	$       19,253.00	$          9,633.00	$                       -
EBT	Cost savings-Depreciation	$        -3,329.00	$      -17,785.00	$       20,747.00	$       30,367.00	$       40,000.00
Tax	0.25% x EBT	$            -832.25	$        -4,446.25	$          5,186.75	$          7,591.75	$       10,000.00
EAT	EBT-Tax	$        -2,496.75	$      -13,338.75	$       15,560.25	$       22,775.25	$       30,000.00
Depreciation	Added back as non cash	$       43,329.00	$       57,785.00	$       19,253.00	$          9,633.00	$                       -
OCF	EAT+Depreciation	$       40,832.25	$       44,446.25	$       34,813.25	$       32,408.25	$       30,000.00

C NPV is calcualted below

Particulars	Remark	0	1	2	3	4	5
Costsavings	Given		$       40,000.00	$       40,000.00	$       40,000.00	$       40,000.00	$       40,000.00
Depreciation	MACRS		$       43,329.00	$       57,785.00	$       19,253.00	$          9,633.00	$                       -
EBT	Cost savings-Depreciation		$        -3,329.00	$      -17,785.00	$       20,747.00	$       30,367.00	$       40,000.00
Tax	0.25% x EBT		$            -832.25	$        -4,446.25	$          5,186.75	$          7,591.75	$       10,000.00
EAT	EBT-Tax		$        -2,496.75	$      -13,338.75	$       15,560.25	$       22,775.25	$       30,000.00
Depreciation	Added back as non cash		$       43,329.00	$       57,785.00	$       19,253.00	$          9,633.00	$                       -
OCF	EAT+Depreciation		$       40,832.25	$       44,446.25	$       34,813.25	$       32,408.25	$       30,000.00
FCINV	Given	-86250
FCF	OCF+FCINV	$       -86,250.00	$       40,832.25	$       44,446.25	$       34,813.25	$       32,408.25	$       30,000.00
Discount factor Formula	at 13%	1/(1+13)^0	1/(1+13)^1	1/(1+13)^2	1/(1+13)^3	1/(1+13)^4	1/(1+13)^5
Discount factor	Calculated using above formula	1	0.884955752	0.783146683	0.693050162	0.613318728	0.542759936
DCF	FCF x Discount Factor	$       -86,250.00	$       36,134.73	$       34,807.93	$       24,127.33	$       19,876.59	$       16,282.80
NPV = sum of all DCF	$                              44,979.38

As NPV is positive the new equipment should be bought