Replacement Analysis The Gilbert Instrument Corporation is considering replacing
ID: 2719154 • Letter: R
Question
Replacement Analysis
The Gilbert Instrument Corporation is considering replacing the wood steamer it currently uses to shape guitar sides. The steamer, purchased just 2 years ago, is being depreciated on a straight-line basis and has 6 years of remaining life. Its current book value is $2,400, and it can be sold on an Internet auction site for $4,500 at this time. Thus, the annual depreciation expense is $2,400/6=$400 per year. If the old steamer is not replaced, it can be sold for $800 at the end of its useful life.
Gilbert is considering purchasing the Side Steamer 3000, a higher-end steamer, which costs $8,000, and has an estimated useful life of 6 years with an estimated salvage value of $800. This steamer falls into the MACRS 5-years class, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The new steamer is faster and would allow for an output expansion, so sales would rise by $2,000 per year; even so, the new machine's much greater efficiency would reduce operating expenses by $1,500 per year. To support the greater sales, the new machine would require that inventories increase by $2,900, but accounts payable would simultaneously increase by $700. Gilbert's marginal federal-plus-state tax rate is 40%, and its WACC is 15%. Should it replace the old steamer?
The old steamer -Select-shouldshould notItem 1 be replaced.
What is the NPV of the project? Round your answer to the nearest dollar.
$
Explanation / Answer
NPV is positive so accept project
Time line 0 1 2 3 4 5 6 Cost of equipment -8000 +selling price of old eqp. 4500 -taxes*(selling price - book value) For old equipment -840 Increase in inventory -2900 Increase in accnt payabe -700 =Initial Investment outlay -7940 Increase in operating income Increase in sales + decrease in costs 3400 3400 3400 3400 3400 3400 MACR rate 20% 32% 19.20% 11.52% 12.00% 5.76% -Depreciation MACR Rate* cost of equipment -1600 -2560 -1536 -921.6 -960 -460.8 + depreciation on old asset 400 400 = 2200 1240 1864 2478.4 2440 2939.2 -taxes =(savings- depreciation)*(1-tax) 1320 744 1118.4 1487.04 1464 1763.52 +Depreciation 1200 2160 1536 921.6 960 460.8 =after tax operating cash flow 2520 2904 2654.4 2408.64 2424 2224.32 -proceeds from salvage value of old equipment =800*(1- 0.4) 480 Reversal of Net working capital 3600 Proceeds from sale of assets =selling price*(1 - tax rate) 480 +Salvage book value * tax rate 0 Terminal year non operating cash flows 4080 Total Cash flow for the period -7940 2520 3384 2654.4 2408.64 2424 6304.32 Discount factor =(1+discount rate)^n 1 1.13 1.2769 1.442897 1.630474 1.842435 2.081952 Discount rate= 13% Discounted cash flows -7940 2230.088 2650.168 1839.632 1477.264 1315.65 3028.082 NPV= Sum of discounted cash flows 4600.885