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 However, even though it is obsolete, it is perfectly functional as originally designed and can be used for quite a while longer.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 $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 $25,000 to $50,000 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 13%. Should the old welder be replaced by the new one?

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

Explanation / Answer

Answer: Old machinery Earnings = $25,000 New machinery earnings = $50,000 Life of new welder = 8 years Depreciation on new welder = 5 years MACRS Corporate tax rate = 40% WACC = 13% Cost of new welder = $84,000 Depreciation on new welder under MACRS Year Rate Depreciation 1 20% $16,800 2 32% $26,880 3 19.20% $16,128 4 11.52% $9,677 5 11.52% $9,677 6 5.76% $4,838 For calculating NPV of the new welder: Year 0 1 2 3 4 5 6 Welder cost ($84,000) Earnings before depreciation $50,000 $50,000 $50,000 $50,000 $50,000 $50,000 Depreciation $16,800 $26,880 $16,128 $9,677 $9,677 $4,838 Earnings After depreciation $33,200 $23,120 $33,872 $40,323 $40,323 $45,162 Tax (40%) $13,280 $9,248 $13,549 $16,129 $16,129 $18,065 Earning after tax $19,920 $13,872 $20,323 $24,194 $24,194 $27,097 Cash flows ($84,000) $36,720 $40,752 $36,451 $33,871 $33,871 $31,935 WACC = 13% Therefore NPV at WACC = $60,169.24 Now for the old welder Earnings are = $25,000 Depreciation = 0 Year 1 2 3 4 5 6 Earnings $25,000 $25,000 $25,000 $25,000 $25,000 $25,000 Tax(40%) $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 Earnig after tax/Cash flows $15,000 $15,000 $15,000 $15,000 $15,000 $15,000 WACC= 13% Therefore NPV at WACC for the old welder = $59,963.25 As the NPV of the old welder is less than the NPV of new welder we should select the new welder.

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