Mississippi River Shipyards is considering the replacement of an 8-year-old rive
ID: 2721221 • 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 $50,000 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 18%. The old machine has been fully depreciated and has no salvage value.
a. What is the NPV of the project? Round your answer to the nearest cent.
b. Should the old riveting machine be replaced by the new one?
Explanation / Answer
a) NPV of the project: Incremental operating cash flows: 1 2 3 4 5 6 7 8 incremental EBDIT 23000 23000 23000 23000 23000 23000 23000 23000 ($50000-$27000) depreciation rate % 20 32 19 12 11 6 depreciation expense 17500 28000 16625 10500 9625 5250 0 0 incremental EBT 5500 -5000 6375 12500 13375 17750 23000 23000 tax @ 40% 2200 -2000 2550 5000 5350 7100 9200 9200 incremental EAT 3300 -3000 3825 7500 8025 10650 13800 13800 add depreciation 17500 28000 16625 10500 9625 5250 0 0 Incremental operating cash flows: 20800 25000 20450 18000 17650 15900 13800 13800 pvif @ 18% 0.8475 0.7182 0.6086 0.5158 0.4371 0.3704 0.3139 0.2660 pv @ 18% 17627 17955 12447 9284 7715 5890 4332 3671 sum of pvs 78921 less: initial investment 87500 NPV -8579 b) The old riveting machine should not be replaced with the new one as the NPV of the replacement is negative.