Replacement Analysis The Gilbert Instrument Corporation is considering replacing
ID: 2766519 • Letter: R
Question
Replacement Analysis
The Gilbert Instrument Corporation is considering replacing the wood steamer it currently uses to shape guitar sides. The steamer, purchased just 2 years ago, is being depreciated on a straight-line basis and has 6 years of remaining life. Its current book value is $2,100, and it can be sold on an Internet auction site for $4,500 at this time. Thus, the annual depreciation expense is $2,100/6=$350 per year. If the old steamer is not replaced, it can be sold for $800 at the end of its useful life.
Gilbert is considering purchasing the Side Steamer 3000, a higher-end steamer, which costs $8,000, and has an estimated useful life of 6 years with an estimated salvage value of $800. This steamer falls into the MACRS 5-years class, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The new steamer is faster and would allow for an output expansion, so sales would rise by $2,000 per year; even so, the new machine's much greater efficiency would reduce operating expenses by $1,500 per year. To support the greater sales, the new machine would require that inventories increase by $2,900, but accounts payable would simultaneously increase by $700. Gilbert's marginal federal-plus-state tax rate is 40%, and its WACC is 15%. Should it replace the old steamer?
The old steamer -Select-shouldshould notItem 1 be replaced.
What is the NPV of the project? Round your answer to the nearest dollar.
$
Explanation / Answer
The Gilbert Instrument Corporation All Amounts in $ If the machine is sold on an as-is-where-is basis the NPV will be calculated on the basis of the following factors : Sale Value net of Tax 2700 NPV $ 215.50 If the new steamer is purchased instead of the old one Depreciation on New Steamer per MACRS for Operating Profit calculation Year Book Value Depreciation Reduction Net (Cost less in Old Depn Salvage Value) Steamer Depreciation 1 7200 1440 350 1090 2 2304 350 1954 3 1382.4 350 1032 4 829.44 350 479.4 5 829.44 350 479.4 6 414.72 350 64.72 Operating Profit working per year, post tax effects @ 60% Year Increase in Decrease in Depreciation Net Income Post Tax Revenue Expenses Income 1 2000 1500 1090 2410 1446 2 2000 1500 1954 1546 927.6 3 2000 1500 1032.4 2468 1480.56 4 2000 1500 479.44 3021 1812.336 5 2000 1500 479.44 3021 1812.336 6 2000 1500 64.72 3435 2061.168 Net Increase in Working Capital at year 0 = $ 2,900 - $ 700 = $ 2,200 Estimated Salvage Value at year end = $ 800 With these values, the Net Present Value of purchasing the steamer works out to -$4,036.75 Hence, since the Net Present Value of purchasing the new steamer is negative, the old steamer should not be replaced.