Replacement analysis The Erley Equipment Company purchased a machine 5 years ago
ID: 2752760 • Letter: R
Question
Replacement analysis
The Erley Equipment Company purchased a machine 5 years ago at a cost of $85,000. The machine had an expected life of 10 years at the time of purchase, and it is being depreciated by the straight-line method by $8,500 per year. If the machine is not replaced, it can be sold for $10,000 at the end of its useful life. A new machine can be purchased for $150,000, including installation costs. During its 5-year life, it will reduce cash operating expenses by $50,000 per year. Sales are not expected to change. At the end of its useful life, the 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%, 45%, 15%, and 7%. The old machine can be sold today for $55,000. The firm's tax rate is 35%. The appropriate WACC is 16%.
A. If the new machine is purchased, what is the amount of the initial cash flow at Year 0? Round your answer to the nearest dollar.
B. What are the incremental net cash flows that will occur at the end of Years 1 through 5? Round your answers to the nearest dollar
C. What is the NPV of this project? Round your answer to the nearest cent.
Explanation / Answer
SOLUTION :
A. If the new machine is purchased, what is the amount of the initial cash flow at Year 0? Round your answer to the nearest dollar
initial cash flow at Year 0 (new machine cost - salvage of old machine) = (150000-55000)
95000
B. What are the incremental net cash flows that will occur at the end of Years 1 through 5? Round your answers to the nearest dollar
Year
savings in operating expense net of taxes (50000*.065)
Incremental depreciation (new machine dep - old machine dep)
tax shield @35% on dep
Incremental net cash flow
a
b
c
d=c*.35
e=b+d
1
32500
41000
14350
46850
2
32500
59000
20650
53150
3
32500
14000
4900
37400
4
32500
2000
700
33200
5
32500
-8500
-2975
29525
c
NPV
Year
savings in operating expense net of taxes (50000*.065)
Incremental depreciation (new machine dep - old machine dep)
tax shield @35% on dep
Incremental net cash flow
Discount factor 16%
Present value
a
b
c
d=c*.35
e=b+d
f
g=e*f
1
32500
41000
14350
46850
0.862068966
40387.93103
2
32500
59000
20650
53150
0.743162901
39499.1082
3
32500
14000
4900
37400
0.640657674
23960.59699
4
32500
2000
700
33200
0.552291098
18336.06445
5
32500
-8500
-2975
29525
0.476113015
14057.23678
Present value of inflow
136240.9375
Present value of outflow
95000
NPV
41,240.94
A. If the new machine is purchased, what is the amount of the initial cash flow at Year 0? Round your answer to the nearest dollar
initial cash flow at Year 0 (new machine cost - salvage of old machine) = (150000-55000)
95000