Mississippi River Shipyards is considering the replacement of an 8-year-old rive
ID: 2717568 • Letter: M
Question
Mississippi River Shipyards is considering the replacement of an 8-year-old riveting machine with a new one that will increase earnings before depreciation from $27,000 to $56,000 per year. The new machine will cost $87,500, 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 14%. The old machine has been fully depreciated and has no salvage value.What is the NPV of the project? Round your answer to the nearest cent.
Explanation / Answer
Solution:
Input Data
The NPV of the project is $3,655.12; therefore, the project is acceptable, hence the old equipment should be replaced.
Solution:
Input Data
Cost of the new machine $12,000 Reducing in operating costs $5,000 New machine salvage value at the end of Year 5 $2,000 Old machine's current market value $1,000 Old machine's current book value $2,500 Increase in Net Operating WC $1,000 Tax rate 40% WACC 14% 1) MACRS 5-year Depreciation Schedule Year 1 2 3 4 5 6 Depreciation rate 20% 32% 19% 12% 11% 6% Depreciation expense = cost of new machine * dep. Rates $2,400 $3,840 $2,280 $1,440 $1,320 $720 2) Replacement Schedule Project Net Cash Flow Schedule Year 0 1 2 3 4 5 Investment Outlay Cost of new equipment ($12,000) Market value of old equipment $1,000 Tax Saving on old equipment sale $600 Increase in Net Operating WC ($1,000) 3) Operating inflows over the Project's Life After tax decreases in costs $3,000 $3,000 $3,000 $3,000 $3,000 Depreciation on new machine $2,400 $3,840 $2,280 $1,440 $1,320 Depreciation on old machine $600 $600 $600 $600 $600 Change in depreciation $1,800 $3,240 $1,680 $840 $720 Tax savings from depreciation @40% $720 $1,296 $672 $336 $288 Net Operating cash flows $2,520 $4,536 $2,352 $1,176 $1,008 Terminal year cash flows $1,000 Estimated salvage value of new machine ($8) Return on Net Operating WC @ 14% $140 $1,132 Net Cash flow ($11,400) $2,520 $4,536 $2,352 $1,176 $2,140 Cummulative Cash flows (for payback) ($11,400) ($8,880) ($4,344) ($1,992) ($816) $1,324 4) Capital Budgeting Analysis Net Present Value (14%) = $26,108*14% ($3,655.12)The NPV of the project is $3,655.12; therefore, the project is acceptable, hence the old equipment should be replaced.