Problem 12-15 Replacement analysis The Erley Equipment Company purchased a machi
ID: 2752928 • Letter: P
Question
Problem 12-15
Replacement analysis
The Erley Equipment Company purchased a machine 5 years ago at a cost of $80,000. 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 $8,000 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 $160,000, including installation costs. During its 5-year life, it will reduce cash operating expenses by $40,000 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 $50,000. The firm's tax rate is 35%. The appropriate WACC is 16%.
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.
$
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
What is the NPV of this project? Round your answer to the nearest cent.
$
Explanation / Answer
Particulars $ Cost of new machinery 160,000 Sale proceeds of old machinery 50,000 Wriitendown value of machinery at the end of 5 years 40,000 Profit 10,000 Tax outflow 3,500 Sale proceeds of old machinery after tax 46,500 Outflow at year 0 113,500 Particulars Year 1 Year 2 Year 3 Year 4 Year 5 Reduction in operating expenses (A) 40,000 40,000 40,000 40,000 40,000 Depreciation on new machine 52,800 72,000 24,000 11,200 - Depreciation of old machine 8,000 8,000 8,000 8,000 8,000 Additional depreciation 44,800 64,000 16,000 3,200 (8,000) Tax gain @ 35% on addl. Dep (B) 15,680 22,400 5,600 1,120 (2,800) Salvage value (for new 0, for old 10000) (C) - - - - (10,000) Incremental cash flow (A+B+C) 55,680 62,400 45,600 41,120 27,200 Discount factor @ 16% 0.86210 0.74320 0.64070 0.55230 0.47610 Discounted Incremental cash flow @ 16% 48,002 46,376 29,216 22,711 12,950 Initial Outflow (113,500) Discounted future cash flow 159,254 NPV 45,754