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 $45,000 per yesr, 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 $55,000. The firm's tax rate is 35%, and the appropriate cost of capital is 12%. a. 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. 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 whole dollar. CF1 CF2 $ CF3 CF4 CFs

Answer 1

Time line		0	1	2	3	4	5
Proceeds from sale of existing asset	=selling price* ( 1 -tax rate)	35750
Tax shield on existing asset book value	=Book value * tax rate	17500
Cost of new machine		-150000
=a. Initial Investment outlay		-96750
3 years MACR rate			33.33%	44.45%	14.81%	7.41%	0.00%	0.00%
Savings			45000	45000	45000	45000	45000
-Depreciation	=Cost of machine*MACR%		-49995	-66675	-22215	-11115	0	0	=Salvage Value
=Pretax cash flows			-4995	-21675	22785	33885	45000
-taxes	=(Pretax cash flows)*(1-tax)		-3246.75	-14088.75	14810.25	22025.25	29250
+Depreciation			49995	66675	22215	11115	0
=after tax operating cash flow			46748.25	52586.25	37025.25	33140.25	29250
+Tax shield on salvage book value	=Salvage value * tax rate						0
=Terminal year after tax cash flows							0
b. Total Cash flow for the period		-96750	46748.25	52586.25	37025.25	33140.25	29250
Discount factor=	(1+discount rate)^corresponding period	1	1.12	1.2544	1.404928	1.5735194	1.7623417
Discounted CF=	Cashflow/discount factor	-96750	41739.50893	41921.43654	26353.84162	21061.228	16597.236
c. NPV=	Sum of discounted CF=	50923.25

Accept project as NPV is positive