Excel Online Structured Activity: Replacement Analysis

The Gilbert Instrument Corporation is considering replacing the wood steamer it currently uses to shape guitar sides. The steamer has 6 years of remaining life. If kept, the steamer will have depreciation expenses of $650 for 5 years and $325 for the sixth year. Its current book value is $3,575, and it can be sold on an Internet auction site for $4,150 at this time. If the old steamer is not replaced, it can be sold for $800 at the end of its useful life.

Gilbert is considering purchasing the Side Steamer 3000, a higher-end steamer, which costs $12,000, and has an estimated useful life of 6 years with an estimated salvage value of $1,200. This steamer falls into the MACRS 5-years class, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The new steamer is faster and would allow for an output expansion, so sales would rise by $2,000 per year; even so, the new machine's much greater efficiency would reduce operating expenses by $1,500 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-state tax rate is 40%, and its WACC is 13%.

The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below.

Open spreadsheet

Should it replace the old steamer?

The old steamer

shouldshould not

be replaced.

What is the NPV of the project? Do not round intermediate calculations. Round your answer to the nearest dollar.

$ fill in the blank 3

45 Annual dpreciation tax savings 46 47 48 49 New equipment 50 Old equipment 51 Change in annual depreciation 52 53 Annual depreciation tax savings 54 55 Step 4: Calculation of net present value of replacement 56 57 Initial investment outlay 58 Annual after-tax revenue increase 59 Annual depreciation tax savings 60 Working capital recovery 61 Salvage value on new equipment 62 63 64 65 66 67 Formulas Tax on salvage value of new equipment Opportunity cost of old equpment Project cash flows Net present value 68 Should firm replace the old equipment? 69 ( = Sheet1 Formulas + B 13.00% -$12,000 $4,150 $2.000 $1,500 Year 1 $650 -$650 Formulas #N/A #N/A #N/A #N/A #N/A Year 2 $650 -$650 D Year 3 $650 -$650 Year 4 E $650 -$650 Year 5 F LL $650 -$650 Year 6 G $325 -$325 H 328 1 2 3 Old Equipment: 4 Depreciation expense, Years 1 to 5 5 Depreciation expense, Year 6 6 Current book value 7 Current market value Market value, Year 6 Replacement Analysis 8 9 10 11 12 13 14 15 16 17 18 X fx A New Equipment Estimated useful life (in years) Purchase price Salvage value, Year 6 Annual sales increase Annual reduction in operating expenses Initial increase in inventories Initial increase in accounts payable 19 20 MACRS depreciation rates (5-year class): 21 22 23 24 25 Tax rate WACC Step 1: Calculation of investment at t=0 4 B $650 $325 $3,575 $4,150 $800 6 $12,000 $1,200 $2,000 $1,500 $2,900 $700 Year 1 20.00% 40.00% 13.00% Year 2 Formulas 32.00% D Year 3 19.20% E Year 4 11.52% F Year 5 11.52% G Year 6 5.76% H