Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

The net present value (NPV) of this replacement project is: -$3,733,074 -$4,230,817 -$5,972,918 -$4,977,432 At times firms will need to decide if they want to

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

-$3,733,074

-$4,230,817

-$5,972,918

-$4,977,432

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.

Johnson 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 16).
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 (NOWC) of $30,000 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 $600,000 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 40%.

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
+ Depreciation T
+ Salvage value
Tax on salvage
NOWC
+ Recapture of NOWC
Total free cash flow

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

Technical Analysis Of Stock Trends

Authors: Robert D. Edwards, John Magee, W.H.C. Bassetti

9th Edition

0814408648, 978-0814408643

More Books

Students also viewed these Finance questions

Question

=+what you can edit out yet still get the message across.

Answered: 1 week ago

Question

=+3. How could you extend the campaign creatively?

Answered: 1 week ago