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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,
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 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 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 working capital (NWC) of $50,000 that will be recovered at the end of the project's life (year 6) . The new machine is more efficient, so the firm's incremental earnings before interest and taxes (EBIT) wl increase by a total of $300,000 in each of the next six years (years 1-6). 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 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 Year 6 Initial investment | $300,000 EBIT -Taxes + New depreciation - Old depreciationn + Salvage value - Tax on salvage - NWC | ? | + Recapture of NWC Total free cash flow $1,710,000
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