Question

At times firms will need to decide if they want to continue to use their current equipment or replace the equipment with newer equipment. The company will need to do replacement analysis to determine which option is the best financial decision for the company.

Price Co. is considering replacing an existing piece of equipment. The project involves the following:

•	The new equipment will have a cost of $1,200,000, and it is eligible for 100% bonus depreciation so it will be fully depreciated at t = 0.
•	The old machine was purchased before the new tax law, so it is 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 operating working capital (NOWC) of $30,000 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 $700,000 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 25%.

Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment.

Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment. Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Initial investment EBIT - Taxes -A Depreciation XT + Salvage value - Tax on salvage - NOWC Recapture of NOWC Total free cash flow - - - - - - The net present value (NPV) of this replacement project is: $1,420,942 O $1,705,130 $1,207,801 O $1,634,083

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

projects (Autosaved) (Autosaved) (Autosaved) - Microsoft Excel (Product Activation Failed) Review File Home Insert Page Layout Formulas Data View Add-Ins E AutoSum - Cut A A Wrap Text Calibri 11 General ECopy Fill Merge & Center Paste в IU* +.0 .00 Conditional Format Cell Insert Delete Format Sort & Find & % Format Painter .00 0 Clear Filter Select Formatting as Table Styles Number Editing Clipboard Font Alignment Styles Cells fox AL123 AG АВ Z А АС AD AE AF АН Al AJ AK AL AM 105 106 0 1 2 3 4 5 6 [SEE NOTE]-900000 107 INITIAL INVESTMENT 700000 700000 700000 700000 700000 700000 108 EBIT TAXES 25% -175000 -175000 109 LESS -175000 -175000 -175000 -175000 110 A DEPRECIATION * TAX RATE -12500 -12500 111 LESS -12500 -12500 0 0 112 ADD SALVAGE VALUE 300000 113 LESS TAX ON SALVAGE -25000 114 LESS NWC -30000 115 ADD RECAPTURE OF NWC 30000 116 512500 A TOTAL FREE CASH FLOW -655000 512500 512500 512500 525000 555000 PV FACTOR@13% 117 В 1 0.8850 0.7831 0.6931 0.6133 0.5428 0.4803 A*B 118 PV OF CFAT -655000 453539.82 401362.68 355188.21 314325.85 284948.97 266576.78 1420942 119 NPV NPV 120 1420942 121 122 AS IT IS A CASE OF 100% BONUS DEPRECIATION NOTE INITIAL INVESTMENT AFTER TAX COST OF MACHINE = 1200000*(1-0.25) = 900000 123 PROFIT ON SALE OF OLD MACHINE = 300000 - 200000 = 100000, SO TAX ON 100000 = 25% OF 100000 = 25000 124 NOTE 125 STEIN indiffEPS EBIT BETA LEVERED REPLACEMENT BOND OPTION TO WAIT LEASE RATIOCASHBUDGET STats Sheet1 NPV RELEVANT MACRS BASE CASE SENSITIVITY II (- Rea erences 120% FFF WA 11:03 ENG 08-11-2019