Replacement analysis Mississippi River Shipyards is considering the replacement
ID: 2768002 • Letter: R
Question
Replacement analysis
Mississippi River Shipyards is considering the replacement of an 8-year-old riveting machine with a new one that will increase earnings before depreciation from $24,000 to $48,000 per year. The new machine will cost $82,500, and it will have an estimated life of 8 years and no salvage value. The new machine will be depreciated over its 5-year MACRS recovery period; so the applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. The applicable corporate tax rate is 40%, and the firm's WACC is 16%. The old machine has been fully depreciated and has no salvage value.
What is the NPV of the project?
Should the old riveting machine be replaced by the new one?
Explanation / Answer
Missisipi River Shipyards NPV Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 MACRS Rate 20.00% 32.00% 19.00% 12.00% 11.00% 6.00% Invetsment in Machine (82,500.00) Incremental Earning before depreciation 24,000 24,000 24,000 24,000 24,000 24,000 24,000 24,000 Less Depreciation (16,500) (26,400) (15,675) (9,900) (9,075) (4,950) - - Taxable Incremental Income= 7,500 (2,400) 8,325 14,100 14,925 19,050 24,000 24,000 Tax @40%= (3,000) 960 (3,330) (5,640) (5,970) (7,620) (9,600) (9,600) Post Tax Incremental Income= 4,500.0 (1,440.0) 4,995.0 8,460.0 8,955.0 11,430.0 14,400.0 14,400.0 Add Back depreciation= 16,500.0 26,400.0 15,675.0 9,900.0 9,075.0 4,950.0 - - Net Cash Flow (82,500.00) 21,000.0 24,960.0 20,670.0 18,360.0 18,030.0 16,380.0 14,400.0 14,400.0 PV factor @16% 1.00 0.862 0.743 0.641 0.552 0.476 0.410 0.354 0.305 PV of Net Cash flows (82,500.0) 18,103.4 18,549.3 13,242.4 10,140.1 8,584.3 6,723.0 5,095.1 4,392.4 NPV=Sum of PV of cash flows= $ 2,330.13 As the NPV of the project is positive , the old rivetting m/c can be replaced with the new one.