Mississippi River Shipyards is considering the replacement of an 8-year-old rive
ID: 2777160 • Letter: M
Question
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 $54,000 per year. The new machine will cost $85,000, 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 18%. The old machine has been fully depreciated and has no salvage value.
Explanation / Answer
Increased Depreciation Net After Tax Cashinflow Year Income %age Amount Income Income (add: Depreciation) 1 30000 20% 17000 13000 7800 24800 2 30000 32% 27200 2800 1680 28880 3 30000 19% 16150 13850 8310 24460 4 30000 12% 10200 19800 11880 22080 5 30000 11% 9350 20650 12390 21740 6 30000 6% 5100 24900 14940 20040 7 30000 0 30000 18000 18000 8 30000 0 30000 18000 18000 Statement of Net Present value of Cashflows: pv factor Present Year Cashflows at 18% Value 0 -85000 1.00000 -85000.00 1 24800 0.84746 21016.95 2 28880 0.71818 20741.17 3 24460 0.60863 14887.11 4 22080 0.51579 11388.62 5 21740 0.43711 9502.75 6 20040 0.37043 7423.45 7 18000 0.31393 5650.65 8 18000 0.26604 4788.69 Total 93000 10399.38 Present value of incremental cashflow is $10,399.38. So, New machine should replace the old machine.