6. Analysis of a replacement project Consider the case of Lohusto Company The managers of Loruste Company are considering replacing an existing piece of equipment, and have collected the folowing information: The new piece of equipment will have a cost of $1,200,000, and it will be depreciated on a straight-line basis over a period of five years The old machine is also being depreciated on a straight-line bacis. It has a book value of $200,000 (st year 0) and the more years of depreciation left($50,000 per year). The new equipment will have a salvage value or so at the end of the project's Me (year 5). The old machine has a current salvage value at your ) of $300.000 Replacing the old machine will require an investment in net working capital (WC) of 545,000 that will be recovered at the end of the projects it year) The new machine is more efficient, so the incremental increase in operating income before taxes will increase by total of 5700,000 in each of the next five years (years 1-5). (Hint: This value represents the difference between the revenues and operating costs (including depreciation expense) generated using the new equipment and that named using the old equipment.) The projects required rate of return is 13 The company's annual tax rates 3 Complete de folosing table and compute the incremental cash flows associated weh the replacement of the old equipment with the new coulement. Year Year 1 Year 2 Year 4 Years Year $700,000 Oper in before ondon Old deprec Networking capital amor networong Goal 5695.000 The ne present value (V) of this placement project is 6. Analysis at a replacement project Consider the case of Lorusse Company The managers of Lorusso Company are considering replacing existing piece of equipment, and have collected the following information The new piece of equipment will have a cost of $1,200,000, and it will be depreciated on a straight-line basis over a period of live years The old machine is also being deprecated on a straight-line basis. It has a book value of $200,000 (at year and the more years of depreciation lett ($50,000 per year) The new equipment will have a salvage value of $0 at the end of the project's We(years). The old machine has a current salvage value (at year D) of $300,000 Replacing the old machine will require an investment in het working capital (WC) of $45,000 that will be recovered at the end of the project's lifecyear 5) . The new machine is more efficient, so the incremental increase in operating income before taxes we increase by a total of $700,000 in each of the next five years (years 1-5). (Hint: This value represents the difference between the revenues and operating costs (including depreciation expense) generated using the new equipment and that earned using the old equipment.) . The project's required rate of return is 13% The company's annual tax rate is 35% Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment Year o Year 1 Year 2 Year 3 Year 4 Year 5 Initial investment Oper inc before $700,000 ) Nie depreciation Old depreciation Net salvage value Net working capital Return of net working capital y $695,000 Totalnet cash flow The net present value (NPV) of this replacement project is
