Question

The Woodruff Corporation purchased a piece of equipment three years ago for $230,000. It has an asset depreciation range (ADR) midpoint of eight years. The old equipment can be sold for $88,750.

A new piece of equipment can be purchased for $302,000. It also has an ADR of eight years.

Assume the old and new equipment would provide the following operating gains (or losses) over the next six years:

Year	New Equipment	Old Equipment
1...............	$81,500	$23,000
2...............	76,500	14,750
3...............	69,750	9,500
4...............	59,500	6,250
5...............	51,250	4,750
6...............	43,000	-5,250

The firm has a 25 percent tax rate and a 9 percent cost of capital.

a. What is the net cost of the new equipment? Round your solution to two decimal places.

b. What is the present value of incremental benefits? Round your solution to two decimal places.

c. What is the NPV of this replacement decision? Round your solution to two decimal places.

Answer 1

A. Calculation New cost of New Equipment

Particulars	Amount ($)
Purchase price of new Equipment	302000
Less - Sold of old Equipment	(88750)
Net Purchase cost of new equipment	213250

B.Calculation of present value of increment benefit

Net income of New Equipment

Year	operating gain / loss	Tax @ 25%	net operating gain / loss
1	81500	20375	61125
2	76500	19125	57375
3	69750	17437.5	52312.5
4	59500	14875	44625
5	51250	12812.5	38437.5
6	43000	10750	32250

net income of old equipment

Year	operating gain / loss	Tax @ 25%	net operating gain / loss
1	23000	5750	17250
2	14750	3687.5	11062.5
3	9500	2375	7125
4	6250	1562.5	4687.5
5	4750	1187.5	3562.5
6	-5250	+1312.5	-3937.5

Year	net operating gain / loss of new equipment	net operating gain / loss of old equipment	incremental net operating gain / loss	PVF @ 9%	Present Value
1	61125	17250	43875	0.9174	40250.93
2	57375	11062.5	46312.5	0.8417	38981.23
3	52312.5	7125	45187.5	0.7722	34893.78
4	44625	4687.5	39937.5	0.7084	28291.73
5	38437.5	3562.5	34875	0.6499	22665.26
6	32250	-3937.5	36187.5	0.5963	21578.61
			Total		$ 186664.54

C. NPV of Replacement Decision -

= Total Present Value -  Net Purchase cost of new equipment

= 186664.54 - 213250

= - 26585.46

NPV is negative that's why project should not accept