Mississippi River Shipyards is considering replacing an 8-year-old riveting mach
ID: 2663837 • Letter: M
Question
Mississippi River Shipyards is considering replacing an 8-year-old riveting machine with a new one that will increase earnings before depreciation from $27,000 to $54,000 per year. The new machine will cost $82,500 and it will have an estimated life of 8 years and no salvage value. The new machine will be depreciated over its 5-year MACRS recovery period; so the applicable depreciation rates are 20%, 32%, 19%, 12%, 11% and 6%. The applicable corporate tax rate is 40%, and the firm's WACC is 12%. The old machine has been fully depreciated and has no salvage value. Should the old riveting machine be replaced by the new one? Explain your answer. (Hint: use NPV)Explanation / Answer
A repalcement yields a higher return, therefore it should be done.
New Machine Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Purchase (82,500) Income 54,000 54,000 54,000 54,000 54,000 54,000 54,000 54,000 Tax Calculation Depreciation 20% 32% 19% 12% 11% 6% Depreciation Expense (16,500) (26,400) (15,675) (9,900) (9,075) (4,950) NOI 37,500 27,600 38,325 44,100 44,925 49,050 54,000 54,000 Tax Rate 40% 40% 40% 40% 40% 40% 40% 40% Tax (15,000) (11,040) (15,330) (17,640) (17,970) (19,620) (21,600) (21,600) NOI after tax 39,000 42,960 38,670 36,360 36,030 34,380 32,400 32,400 Cash Flow (82,500) 39,000 42,960 38,670 36,360 36,030 34,380 32,400 32,400 NPV @12% $91,790.32 Old Machine Purchase - Income 27,000 27,000 27,000 27,000 27,000 27,000 27,000 27,000 Tax (10,800) (10,800) (10,800) (10,800) (10,800) (10,800) (10,800) (10,800) Cash Flow - 16,200 16,200 16,200 16,200 16,200 16,200 16,200 16,200 NPV @ 12% $71,853.36