At times firms vill need to decide if they want to continue to use their current

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At times firms vill need to decide if they want to continue to use their current equipment or replace the equipment with newer equipment The company will need to do replacement analysis to determine which option is the best fnancial decision for the company ohnson Co. is considering replacing an existing piece of equipment. The project involves the following: The new equipment will have a cost of $2,400,000, and it will be depreciated on a straight-line basis over a period of six years (years 1-6) The old machine is also being depreciated on a straight-line basis. It has a book value of200,000 (at year 0) and four more years of depreciation left ($50,000 per year). * The new equipment will have a salvage value of $0 at the end of the project's life (year 6). The old machine has a current salvage value (at year 0) of $300,000. .Replacing the old machine will require an investment in net working capital (NWC) of $45,000 that will be recovered at the end of the project's life (year The new machine is more efficient, so the firm's incremental earnings before interest and taxes (EBIT) will increase by a total of $500,000 in each of the next six years (years 1-6). Hint: This value represents the difference between the revenues and operating costs (indluding depreciation expense) generated using the new equipment and that earned using the old equipment. * The project's cost of capital is 13% * The company's annual tax rate is 40%

Explanation / Answer

0 1 2 3 4 5 6 Initial investment 2400000 EBIT 500000 500000 500000 500000 500000 500000 -Taxes 200000 200000 200000 200000 200000 200000 +New depreciation 400000 400000 400000 400000 400000 400000 -Old depreciation 50000 50000 50000 50000 0 0 +Salvage value 300000 -Tax on salvage 40000 -NWC 45000 +Recapture of NWC 45000 Total free cash flow -2185000 650000 650000 650000 650000 700000 745000 PVIF at 13% 1 0.8849558 0.78315 0.69305 0.61332 0.54276 0.48032 PV at 13% -2185000 575221 509045 450483 398657 379932 357837 486176 NPV $      486,176 Answer

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