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Replacement Analysis The Everly Equipment Company's flange-lipping machine was purchased 5 years ago for $80,000. It...

Replacement Analysis

The Everly Equipment Company's flange-lipping machine was purchased 5 years ago for $80,000. It had an expected life of 10 years when it was bought and its remaining depreciation is $8,000 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 $50,000 per year, 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%.

  1. 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.
    $



  2. 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 $
    CF5 $

  3. What is the NPV of this project? Do not round intermediate calculations. Round your answer to the nearest whole dollar.
    $  

    Should Everly replace the flange-lipper?
        -Select-YesNoItem 8
0 0
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Answer #1
Calculation of initial cash flow at year 0
Book value of machine $40,000
80000-(5*8000)
Sale of machine $55,000
Gain on sale of machine $15,000
Tax on sale of machine 15000*35% -$5,250
Total cash received 55000-5250 $49,750
Purchase price of new machine -$150,000
Cash outflow at year 0 150000-49750 -$100,250
Cash outflow at year 0 is -$100,250
Calculation of changes in depreciation
Year MACRS rate Depreciable basis Depreciation (new) Depreciation (old) Changes in depreciation expense Tax shield on depreciation (Changes in depreciation expense*Tax rate)
1 33.33% $150,000 $49,995 $8,000 $41,995 $14,698.25
2 44.45% $150,000 $66,675 $8,000 $58,675 $20,536.25
3 14.81% $150,000 $22,215 $8,000 $14,215 $4,975.25
4 7.41% $150,000 $11,115 $8,000 $3,115 $1,090.25
5 $8,000 -$8,000 -$2,800.00
Calculation of incremental net cash flows
Year After tax savings in operating expense (Expense*(1-tax rate)) Tax shield on depreciation Total incremental net cash flows
1 32500.0 $14,698.25 $47,198.25
2 32500.0 $20,536.25 $53,036.25
3 32500.0 $4,975.25 $37,475.25
4 32500.0 $1,090.25 $33,590.25
5 32500.0 -$2,800.00 $29,700.00
Net present value is present value of cash inflow less present value of cash outflow
Calculation of net present value
Year Incremental net cash flow Discount factor @ 12% Present value
0 -$100,250 1.00000 -$100,250.00
1 $47,198.25 0.89286 $42,141.29
2 $53,036.25 0.79719 $42,280.17
3 $37,475.25 0.71178 $26,674.14
4 $33,590.25 0.63552 $21,347.21
5 $29,700.00 0.56743 $16,852.58
NPV $49,045.40
The net present value is $49,045
Since the NPV of the project is positive, Everly should replace the flange lipper.
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