Question

Replacement Analysis St. Johns River Shipyard's welding machine is 15 years old, fully depreciated, and has no salvage value. However, even though it is old, it is still functional as originally designed and can be used for quite a while longer. The new welder will cost $81,500 and have an estimated life of 8 years with no salvage value. The new welder will be much more efficient, however, and this enhanced efficiency will increase earnings before depreciation from $26,000 to $52,000 per year. The new machine will be depreciated over its 5-year MACRS recovery period, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The applicable corporate tax rate is 40%, and the firm's WACC is 15%. Should the old welder be replaced by the new one? Old welder -Select- Abe replaced. What is the NPV of the project? Round your answer to the nearest cent. $

Answer 1

81500 years Given Price of new welder Life Salvage Value Depriciation Rates 20% 32% 19.20% 11.52% 11.52% 5.76% Increase in earning (52000-26000) Marginal Tax Rate WACC 26000 40% 15% Solution Step 1: Annual depriciation allowance Year Depriciation New 16300 26080 15648 9388.8 9388.8 76805.6 5 Total Step2: Incremental Cash Flow Year Depriciation Annual Saving 26000 26000 26000 26000 26000 26000 26000 26000 16300 26080 15648 9388.8 9388.8 o 0 0 CFAD CFADT 9700 5820 -801 -48 10352 6211.2 16611.2 9966.72 16611.2 9966.72 26000 15600 26000 15600 26000 15600 Net Cash Flow 22120 26032 21859 19356 19356 15600 15600 15600 7 8 where, Depreciation (Dep.) CFAD CFADT (Cash flow after Dep. & Tax) = Net Cash Flow Fictional Cash Flow (Used on for Tax Calulation) Cash flow after depriciation CFAD X (1 - Tax Rate) CFADT + Depreciation Step 3: Calculate NPV Book Value of New asset at end of 5th Year Cost Price Less: Sum of Depriciation years 1 to 5 81500 76805.6

Book Value at end of 5th year 4694.4 Cashflow due to new asset at end of 5th year Salvage Value Add: Tax Saving Cashflow 1877.76 1877.76 Note: Tax Saving = (Book Value - Salvage Value) X Tax Rate pv Net Cash Year PVE Flow -81500 1 22120 0.870| 26032 0.756 3 21859 0.6581 19356 0.572| 5 19356 0 .497 6 156001 0.432 7 15600 0.376 15600 0.327 8* 1877.76 0.327 NPV Note: 8* is cashflow due to sale of new asset -81500 19234.78 19683.93 14372.65 11066.86 9623.35 6744.31 5864.62 5 099.67 613.84 10804.01 8 (1/(1+r)^n PVF (Present Value Factor) = where r is discount rate, n is year PV (Present Value) = CFC X PVF Hence, old welder must be replaced as NPV of replacing is $10804.01