Replacement Analysis The Gilbert Instrument Corporation is considering replacing
ID: 2766629 • 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
Answer Incremental Investment in new steamer Cost of new Steamer 8000 Sale proceeds of old steamer 4500 ------------- Incremental investment 3500 ------------- Computation of Incremental Depreciation Year old steamer New steamer Incremental Deperciation 1 350 1600.00 1250.00 2 350 2560.00 2210.00 3 350 1536.00 1186.00 4 350 921.60 571.60 5 350 921.60 571.60 6 350 460.80 110.80 Computation of NPV Year Inc Revenue Expenses saved Total saving Inc Dep Profit Befor tax Tax @ 40% Net Profit Cash Inflow PVIF @ 15% Present Value A B C= A+B D E = C-D F G= E-F H = G+D I J = I*H 1 2000 1500 3500 1250.00 2250.00 900.00 1350.00 2600.00 0.870 2262.00 2 2000 1500 3500 2210.00 1290.00 516.00 774.00 2984.00 0.756 2255.90 3 2000 1500 3500 1186.00 2314.00 925.60 1388.40 2574.40 0.658 1693.96 4 2000 1500 3500 571.60 2928.40 1171.36 1757.04 2328.64 0.572 1331.98 5 2000 1500 3500 571.60 2928.40 1171.36 1757.04 2328.64 0.497 1157.33 6 2000 1500 3500 110.80 3389.20 1355.68 2033.52 2144.32 0.432 926.35 Total 9627.52 Cash of Inventory relased (2900-700) 2200 PVIF @ 15% 0.432 Present value of cash release 950.4 950.4 Total present value of cash inflow 10577.92 Less Initial out lay Incremental investment in steamer 3500 Investment in Inventory (2900-700) 2200 5700 NPV of the project 4877.92 Therefore old steamer should be replaced.