Question

Please help me fill in all blanks as well as the multiple choice question. Thanks!

Price Co. is considering replacing an existing piece of equipment. The project involves the following: • The new equipment will have a cost of $600,000, and it will be depreciated on a straight-line basis over a period of six years (years 1-6). • The old machine is also being depreciated on a straight-line basis. It has a book value of $200,000 (at year 0) and four more years of depreciation left ($50,000 per year). • The new equipment will have a salvage value of $0 at the end of the project's life (year 6). The old machine has a current salvage value (at year 0) of $300,000 • Replacing the old machine will require an investment in net working capital (NWC) of $45,000 that will be recovered at the end of the project's life (year 6). The new machine is more efficient, so the firm's incremental earnings before interest and taxes (EBIT) will increase by a total of $600,000 in each of the next six years (years 1-6). Hint: This value represents the difference between the revenues and operating costs (including depreciation expense) generated using the new equipment and that earned using the old equipment. • The project's cost of capital is 13%. • The company's annual tax rate is 30%. Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment. Year o Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 $600,000 Initial investment EBIT - Taxes + New depreciation - Old depreciation + Salvage value - Tax on salvage - NWC + Recapture of NWC Total free cash flow G O $520,000 $520,000 The net present value (NPV) of this replacement project is: O $1,340,124 $1,576,617 $1,891,940 $1,813, 110

Answer 1

	Year 0	Year 1	2	3	4	5	6
Initial Investment	-600000
EBIT		600000	600000	600000	600000	600000	600000
Taxes		180000	180000	180000	180000	180000	180000
New Depreciation		100000	100000	100000	100000	100000	100000
Old Depreciation		50000	50000	50000	50000	0	0
Salvage value	300000
Tax on salvage	-30000
NWC	-45000
Recapture of NWC							45000
Total free cash flow	-375000	470000	470000	470000	470000	520000	565000
PVF	1	0.884955752	0.783146683	0.693050162	0.613318728	0.542759936	0.480318527
PV	-375000	415929.2035	368078.9412	325733.5763	288259.802	282235.1667	271379.968
NPV	1576616.658
Hence, NPV = $1,576,617