Analysis of a replacement project

Consider the case of LoRusso Company:

The managers of LoRusso Company are considering replacing an 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 five years.

The old machine is also being depreciated on a straight$-$line basis. It has a book value of $$200,000($at year o$)$ and three more years of depreciation left $($ $$50,000$ per year$).$

The new equipment will have a salvage value of $$0$ at the end of the project's life $($year $5).$ The old machine has a current salvage value $($at year $0)$ of $$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 $5).$

The new machine is more efficient, so the incremental increase in operating income before taxes will increase by a total of $5500,000$ 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 $11\%.$

The company's annual tax rate is $30\%.$

Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment.

Year $0$

Year $1$

Year $2$

Year $3$

Year $4$

Year $5$

Return of net

working capital

Total net cash flow

The net present value $($NPV$)$ of this replacement project is