Gilbert is considering purchasing the Side Steamer 3000 which cost $12,000 and h
ID: 2772979 • Letter: G
Question
Gilbert is considering purchasing the Side Steamer 3000 which cost $12,000 and has an estimated useful life of 6 years with an estimate salvage value of $1,500. This steamer falls into the NARC 5-year class with rates as 20.00%, 32.00%, 19.20%, 11.52%, 11.52% and 5.76%. The new steamer sales will raise by $2,000 per year; the new would reduce operating expenses by $1,900 per year. To support the greater sales, the new machine would require that inventories increase by $2,900, but accounts payable would simultaneously increase by $700. Gilbert’s marginal federal-plus tax rate is 40% and its WACC is 15%. Should it replace the old steamer?
Explanation / Answer
Net Present Value = $ 7,908.76
Since Net Present Value is Positive, the firm should replace its old steamer
working
Cost of new steamer = $ 12,000
Estimated Life = 6 years
Salvage Value = $ 1500
Marginal Tax Rate = 40%
WACC = 15%
Depreciation Rates = 20%, 32%, 19.20%, 11.52%, 11.52% and 5.76%
Net Change in cash flows = Increase in inventories – increase in accounts payable
= $ 2900 - $ 700 = $ 2,200
Estimated cash flows
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Increase in Sales---1
2000
2000
2000
2000
2000
2000
Decrease in Operating Expenses—2
1900
1900
1900
1900
1900
1900
Depreciation
2400
3840
2304
1382.40
1382.40
691.20
Depreciation * (1-Tax Rate) –3
1440
2304
1382.40
829.44
829.44
414.72
Net Cash Flow 1+2+3
5340
6204
5282.40
4729.44
4729.44
4314.72
Discounting factor 1/1+r)^n r=0.12 and n = 6
0.8929
0.7972
0.7118
0.6355
0.5674
0.5066
Discounted Flows = Net Flow * Discounting Factor
4768.09
4945.83
3760.01
3005.56
2683.48
2185.84
Total of Discounted cash flows = $ 21,348.81
Present Value of Salvage Value = $1500/1.12^6 = 1500/1.973822685 = $ 759.95
Net Present Value
NPV = - Initial Investment – Increase in Working Capital + Total discounted cash flows + Present value of Salvage Value
NPV= -$ 12,000 - $ 2,200 + $ 21,348.81 + $ 759.95
NPV = $ 7,908.76
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Increase in Sales---1
2000
2000
2000
2000
2000
2000
Decrease in Operating Expenses—2
1900
1900
1900
1900
1900
1900
Depreciation
2400
3840
2304
1382.40
1382.40
691.20
Depreciation * (1-Tax Rate) –3
1440
2304
1382.40
829.44
829.44
414.72
Net Cash Flow 1+2+3
5340
6204
5282.40
4729.44
4729.44
4314.72
Discounting factor 1/1+r)^n r=0.12 and n = 6
0.8929
0.7972
0.7118
0.6355
0.5674
0.5066
Discounted Flows = Net Flow * Discounting Factor
4768.09
4945.83
3760.01
3005.56
2683.48
2185.84
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