Question

The Gilbert Instrument Corporation is considering replacing the wood steamer it cur-rently uses to shape guitar sides. The steamer has 6 years of remaining life. If kept, the steamer will have depreciation expenses of $650 for 5 years and $325 for the sixth year. Its current book value is $3,575, and it can be sold on an Internet auction site for $4,150 at this time. If the old steamer is not replaced, it can be sold for $800 at the end of its useful life. Gilbert is considering purchasing the Side Steamer 3000, a higher-end steamer, which
costs $12,000 and has an estimated useful life of 6 years with an estimated salvage value of $1,500. This steamer falls into the MACRS 5-year class, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The new steamer is faster and allows for an output expansion, so sales would rise by $2,000 per year; the new machine’s much greater efficiency would reduce operating expenses by $1,900 per year. To support the greater sales, the new machine would require that inventories increase by $2,900, but ac-counts payable would simultaneously increase by $700. Gilbert’s marginal federal-plus-state tax rate is 25%, and the project cost of capital is 15%. Should it replace the old steamer?

Answer 1

(a) prefent value of cash out goinge 12000 - 4150 7850 x1 7850 8335 (6) Capital cost 12000 Selling price of old ncrease in Inventories 2200 [2900-700] 2200 * 3.784 present value of cash goflows Increase in salvage : 700 x 0.432 Increase in sales : 2000 x 3-784 Tax saring in variable cost: 1900 ×(1-0-25) x 3.784 Tax Savings on Depreciation: Cworkingniste) 303 7568 5393 148.7 14750 cash Ioflows (Present value) - cash outflows (presst valce) = 11435] The company should not replace the machine as outgoings are more

PV Working notes - Years New Depreciation - old Dep? 2400 650 Depreciation xtax DF @ 15%. Additional Depreciation 1750 3190 380.625 3840 B1 3705 797.5 650 0.870 0.756 602.91 - am so 2260 650 1630 407.5 0.658 268.135 1382 650 732 183 0 571 104.5 1382 650 732 183 0-497 691 325 366 91.5 90.9 39.53 0-432 1486-6

Machine - steamer, old- old steamer, New- New steamer

DF- Cost of capital which is also known as Discounting factor which is 15%.

You can find discounting factor for each year in working notes.