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

Question

St. Johns River Shipyards's welding machine is 15 years old, fully depreciated, obsolete, and has no salvage value. However, even though it is obsolete, it is perfectly functional as originally designed and can be used for quite a while longer. The new welder will cost $80,000, 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 $26,000 to $52,000 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 11%.

Should the old welder be replaced by the new one? (Yes/No)

What is the NPV of the project? Round your answer to the nearest cent.

Explanation / Answer

Lets us first discuss about MACRS recovery period.

In this depreciation method the expenses will be depreciated as per the given rates i.e first year it will be depreciated by 20% i.e .2*80000 = 16000 and 2nd year by 32% i.e .32*80000 = 25600 and so on and so forth.

WACC = 11% which is used for discounting the cash flows

Cash flows with old welder

Sum of the present Value of cash flows if an old welder is used = 80279.2

Cash flows with New welder:

Hence it financially makes more sense to go with the old welder.

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 New Welder Revenues 26000 26000 26000 26000 26000 26000 26000 26000 PAT @ 40% 15600 15600 15600 15600 15600 15600 15600 15600 PV OW 14054.05 12661.31 11406.59 10276.2 9257.841 8340.397 7513.871 6769.253 Sum of PV 80279.52

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