The Everly Equipment Company\'s flange-lipping machine was purchased 5 years ago
ID: 2766181 • Letter: T
Question
The Everly Equipment Company's flange-lipping machine was purchased 5 years ago for $100,000. It had an expected life of 10 years when it was bought and is being depreciated by the straight-line method by $10,000 per year. As the older flange-lippers are robust and useful machines, it can be sold for $20,000 at the end of its useful life.
A new high-efficiency digital-controlled flange-lipper can be purchased for $140,000, including installation costs. During its 5-year life, it will reduce cash operating expenses by $50,000 per year, although it will not affect sales. At the end of its useful life, the high-efficiency machine is estimated to be worthless. MACRS depreciation will be used, and the machine will be depreciated over its 3-year class life rather than its 5-year economic life, so the applicable depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%.
The old machine can be sold today for $55,000. The firm's tax rate is 35%, and the appropriate WACC is 15%.
If the new flange-lipper is purchased, what is the amount of the initial cash flow at Year 0? Round your answer to the nearest whole dollar.
$
What are the incremental net cash flows that will occur at the end of Years 1 through 5? Round your answers to the nearest whole dollar.
What is the NPV of this project? Round your answer to the nearest whole dollar.
$
Should Everly replace the flange-lipper?
Explanation / Answer
Solution :
Initial outlay :
Old depreciation = 10000 per year
Book value = 100000 - 5 (10000) = 50000
Gain = 55000 - 50000 = 5000
Tax on book gain = 5,000 (0.35) = 1750
Price
- 140,000
SV (old machine)
55,000
Tax effect
- 1,750
Initial outlay
- 86,750
incremental net cash flows :
.
Recovery
Depreciation
Depreciation
Depreciation
Change in
Year
Percentage
Basis
Allowance, New
Allowance, Old
Depreciation
1
0.33
140000.00
46662.00
10000.00
36662.00
2
0.44
140000.00
62230.00
10000.00
52230.00
3
0.15
140000.00
20734.00
10000.00
10734.00
4
0.07
140000.00
10374.00
10000.00
374.00
5
10000.00
-10000.00
Years
after tax savings in operating expense (50000*0.65)
** Tax sheild on depreciation
salvage
Incremental cash flow
1
32,500
12,832
45,332
2
32,500
18,281
50,781
3
32,500
3,757
36,257
4
32,500
131
32,631
5
32,500
- 3,500
- 10,000
19,000
**change in depreciation*35%
NPV :
Years
after tax savings in operating expense
Tax sheild on depreciation
salvage
Incremental cash flow
DF at 15%
PV
1
32,500
12,832
45,332
0.86957
39,419
2
32,500
18,281
50,781
0.75614
38,397
3
32,500
3,757
36,257
0.65752
23,840
4
32,500
131
32,631
0.57175
18,657
5
32,500
- 3,500
- 10,000
19,000
0.49718
9,446
129,759
PV of initial outlay
- 86,750
NPV
43,009
Therefore, the firm should replace the old machine.
Old depreciation = 10000 per year
Book value = 100000 - 5 (10000) = 50000
Gain = 55000 - 50000 = 5000
Tax on book gain = 5,000 (0.35) = 1750
Price
- 140,000
SV (old machine)
55,000
Tax effect
- 1,750
Initial outlay
- 86,750
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