Please show work and finish entire question. Do not do in Excel. The Everly Equi
ID: 2742591 • Letter: P
Question
Please show work and finish entire question. Do not do in Excel.
The Everly Equipment Company’s flange-lipping machine was purchased 5 years ago for $55,000. It had an expected life of 10 years when it was bought and its remaining depreciation is $5,500 per year for each year of its remaining life. As the older flange-lippers are robust and useful machines, it 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 $120,000, including installation costs. During its 5-year life, it will reduce cash operating expenses by $30,000 per year, although it will not affect sales. At the end of its useful life, the highefficiency 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 $35,000. The firm’s tax rate is 35%, and the appropriate WACC is 16%.
a. If the new flange-lipper is purchased, what is the amount of the initial cash flow at Year 0?
b. What are the incremental net cash flows that will occur at the end of Years 1 through 5?
c. What is the NPV of this project? Should Everly replace the flange-lipper?
Explanation / Answer
a) INITIAL CASH FLOW AT YEAR '0': cost of the new flange lipper 120000 less: sale value of old machine 35000 less: income tax on capital gain on old machine (35000-5500*5)*0.35 2625 net initial cash flow 82375 b) INCREMENTAL NET CASH FLOWS: 1 2 3 4 5 savings in operating costs (net of tax of 35%) -A 19500 19500 19500 19500 19500 depreciation on the new machine 39996 53340 17772 8892 MACRS depreciation rate 33.33% 44.45% 14.81% 7.41% 0.00% depreciation on the old machine 5500 5500 5500 5500 5500 incremental depreciation 34496 47840 12272 3392 -5500 tax on incremental depreciation - B 12074 16744 4295 1187 -1925 incremental net operating cash flows (A+B) 31574 36244 23795 20687 17575 salvage value (net of tax) lost on old machine (20000*.65) -13000 incremental net cash flows 31574 36244 23795 20687 4575 c) NPV OF THE PROJECT: incremental net cash flows 31574 36244 23795 20687 4575 pvif @ 16% 0.8621 0.7496 0.6518 0.5668 0.4929 PV at 16% 27219 27169 15511 11726 2255 Total PV of cash inflows 83880 Less: initial investment 82375 NPV 1505 Yes, Everly should replace the old flange lipper as the NPV of the replacement is positive at $1505.