Asset-Replacement Decision; NPV Analysis Assume a situation in which a company has an

existing asset, A, that has a current net book value (original cost less accumulated depreciation to

date) of $300,000. This asset has a useful life of 3 additional years. Its estimated disposal (sales)

value both today and at the end of 3 years is estimated to be zero. Asset B, which would replace

A could be purchased today for $600,000. If purchased, B would generate annual (cash) operating

cost savings (pretax) of $280,000 for each year of its 3-year useful life. In determining depreciation deductions for tax purposes, assume the straight-line method and zero salvage value for both assets.

The company is subject to a combined (federal, state, and local) income tax rate of 40%, both for

operating income and gains/losses related to the sale of assets. Other than the initial outlay for asset

B, assume that all cash flows (and related tax payments) occur at the end of the year. Assume a

weighted-average cost of capital of 10%.

Required

1. Determine the relevant (i.e., differential) cash flows (after-tax) at each of the following three points

related to this asset-replacement decision: (1) project initiation (i.e., time 0), (2) project operation (i.e.,

end of years 1, 2, and 3), and (3) project disposal/termination (i.e., end of year 3).

2. What is the estimated net present value of the decision to replace asset A (the existing asset) with asset

B? Use the built-in NPV function in Excel and round your final answer to the nearest whole dollar.

3. What is the weighted-average cost of capital (WACC) that would make the company indifferent between

keeping or replacing asset A? Use the Goal Seek option in Excel to answer this question; round your

answer to 2 decimal places (e.g., 13.418% = 13.42%.)