Replacement decision analysis Zagloba Corporation purchased a piece of equipment
ID: 2749108 • Letter: R
Question
Replacement decision analysis
Zagloba Corporation purchased a piece of equipment four years ago for $300,000. It has an asset depreciation range (ADR) midpoint of fourteen years. The old equipment can be sold for $125,000.
A new piece of equipment can be purchased for $400,000. It also has an ADR of 14 years
ADR of 14 years indicates the use of the 7-year MACRS schedule
Assume the old and new equipment would provide the following operating gains (or losses) over the next eight years.
Year
New Equipment
Old Equipment
1
$ 150,000
$ 35,000
2
100,000
20,000
3
80,000
20,000
4
75,000
19,000
5
65,000
15,000
6
45,000
10,000
7
35,000
5,000
8
25,000
(10,000)
The firm has a 35 percent tax rate and an 11 percent cost of capital. Should the new equipment be purchased to replace the old equipment? Calculate the NPV and the IRR of the after tax cost savings and tax shield benefits from depreciation.
Prepare your analysis using Excel
Year
New Equipment
Old Equipment
1
$ 150,000
$ 35,000
2
100,000
20,000
3
80,000
20,000
4
75,000
19,000
5
65,000
15,000
6
45,000
10,000
7
35,000
5,000
8
25,000
(10,000)
Explanation / Answer
New Equipment Depreciation Calculation Year Book value year start Dep Book Value year end 1 $ 4,00,000 $ 57,160 $ 3,42,840 2 $ 3,42,840 $ 97,960 $ 2,44,880 3 $ 2,44,880 $ 69,960 $ 1,74,920 4 $ 1,74,920 $ 49,960 $ 1,24,960 5 $ 1,24,960 $ 35,720 $ 89,240 6 $ 89,240 $ 35,680 $ 53,560 7 $ 53,560 $ 35,720 $ 17,840 8 $ 17,840 $ 17,840 $ 0 Calculation of NPV Year Cash flow Less : Dep Income Before tax Less : tax Net Net Income+Dep Cash flow DCF 0 $ -275000.00 $ 0.00 $ -275000.00 $ -275000.00 $ -275000.00 $ -275000.00 1 $ -275000.00 1 $ 150000.00 $ 57160.00 $ 92840.00 $ 32494.00 $ 60346.00 $ 117506.00 0.900901 $ 105861.26 2 $ 100000.00 $ 97960.00 $ 2040.00 $ 714.00 $ 1326.00 $ 99286.00 0.811622 $ 80582.74 3 $ 80000.00 $ 69960.00 $ 10040.00 $ 3514.00 $ 6526.00 $ 76486.00 0.731191 $ 55925.90 4 $ 75000.00 $ 49960.00 $ 25040.00 $ 8764.00 $ 16276.00 $ 66236.00 0.658731 $ 43631.70 5 $ 65000.00 $ 35720.00 $ 29280.00 $ 10248.00 $ 19032.00 $ 54752.00 0.593451 $ 32492.65 6 $ 45000.00 $ 35680.00 $ 9320.00 $ 3262.00 $ 6058.00 $ 41738.00 0.534641 $ 22314.84 7 $ 35000.00 $ 35720.00 $ -720.00 $ -252.00 $ -468.00 $ 35252.00 0.481658 $ 16979.42 8 $ 25000.00 $ 17840.00 $ 7160.00 $ 2506.00 $ 4654.00 $ 22494.00 0.433926 $ 9760.74 NPV $ 92549.27 Old Equipment Depreciation Calculation Year Book value year start Dep Book Value year end 1 $ 3,00,000 $ 42,870 $ 2,57,130 2 $ 2,57,130 $ 73,470 $ 1,83,660 3 $ 1,83,660 $ 52,470 $ 1,31,190 4 $ 1,31,190 $ 37,470 $ 93,720 5 $ 93,720 $ 26,790 $ 66,930 6 $ 66,930 $ 26,760 $ 40,170 7 $ 40,170 $ 26,790 $ 13,380 8 $ 13,380 $ 13,380 $ 0 Calculation of NPV Year Cash flow Less : Dep Income Before tax Less : tax Net Net Income+Dep DF DCF 0 $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00 1 $ 0.00 1 $ 35000.00 $ 26790.00 $ 8210.00 $ 2873.50 $ 5336.50 $ 32126.50 0.900901 $ 28942.79 2 $ 20000.00 $ 26760.00 $ -6760.00 $ -2366.00 $ -4394.00 $ 22366.00 0.811622 $ 18152.75 3 $ 20000.00 $ 26790.00 $ -6790.00 $ -2376.50 $ -4413.50 $ 22376.50 0.731191 $ 16361.50 4 $ 19000.00 $ 13380.00 $ 5620.00 $ 1967.00 $ 3653.00 $ 17033.00 0.658731 $ 11220.16 5 $ 15000.00 $ 0.00 $ 15000.00 $ 5250.00 $ 9750.00 $ 9750.00 0.593451 $ 5786.15 6 $ 10000.00 $ 0.00 $ 10000.00 $ 3500.00 $ 6500.00 $ 6500.00 0.534641 $ 3475.17 7 $ 5000.00 $ 0.00 $ 5000.00 $ 1750.00 $ 3250.00 $ 3250.00 0.481658 $ 1565.39 8 $ -10000.00 $ 0.00 $ -10000.00 $ -3500.00 $ -6500.00 $ -6500.00 0.433926 $ -2820.52 NPV $ 82683.39