Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

At times firms will need to decide if they want to continue to use their current equipment or replace the equipment with newer equipment. The

At times firms will 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 financial decision for the company.
Price Co. is considering replacing an existing piece of equipment. The project involves the following:
The new equipment will have a cost of $9,000,000, and it is eligible for 100% bonus depreciation so it will be fully depreciated at t =0.
The old machine was purchased before the new tax law, so it is being depreciated on a straight-line basis. It has a book value of $200,000(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 operating working capital (NOWC) of $60,000 that will be recovered at the end of the project's life (year 6).
The new machine is more efficient, so the firms incremental earnings before interest and taxes (EBIT) will increase by a total of $700,000 in each of the next six years (years 16). 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 cost of capital is 13%.
The company's annual tax rate is 25%.
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
Year 6
Initial investment
EBIT
Taxes
\Delta Depreciation \times T
+ Salvage value
Tax on salvage
NOWC
+ Recapture of NOWC
Total free cash flow
The net present value (NPV) of this replacement project is:
-$5,111,345
-$3,333,486
-$3,777,951
-$4,444,648
image text in transcribed

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Financial Institutions Management A Risk Management Approach

Authors: Anthony Saunders, Marcia Cornett, Otgo Erhemjamts

10th Edition

1260013820, 978-1260013825

More Books

Students also viewed these Finance questions

Question

Recognize and discuss the causes of culture shock

Answered: 1 week ago