St. Johns River Shipyard\'s welding machine is 15 years old, fully depreciated,

Question

St. Johns River Shipyard's welding machine is 15 years old, fully depreciated, and has no salvage value. However, even though it is old, it is still functional as originally designed and can be used for quite a while longer. The new welder will cost $84,000 and have an estimated life of 8 years with no salvage value. The new welder will be much more efficient, however, and this enhanced efficiency will increase earnings before depreciation from $28,000 to $56,000 per year. The new machine will be depreciated over its 5-year MACRS recovery period, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The applicable corporate tax rate is 40%, and the firm's WACC is 15%. Should the old welder be replaced by the new one? Old welder should/ should not be replaced. What is the NPV of the project?

Explanation / Answer

Answer:

If NPV of the cashflow from the new welder is positive than the old welder be replaced by the new one.

Incremental Cashflow from the new welder:

Calculation of Net present value of the cashflows:

As the NPV is positive, the old welder be replaced by the new one.

A B C=A+B Year Increse in Earning Depreciation Increase in earning after depreciation Tax @ 40% Increased earning after tax Incresed Cashflow 1 28000 16800 11200 4480 6720 23520 2 28000 26880 1120 448 672 27552 3 28000 16128 11872 4748.8 7123.2 23251.2 4 28000 9676.8 18323.2 7329.28 10993.92 20670.72 5 28000 9676.8 18323.2 7329.28 10993.92 20670.72 6 28000 4838.4 23161.6 9264.64 13896.96 18735.36 7 28000 28000 11200 16800 16800 8 28000 28000 11200 16800 16800

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