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 $14,000, and has an estimated useful life of 6 years with an estimated salvage value of $1,400. 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 $1,400 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 15%.

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.

Should it replace the old steamer?

The old steamer 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

Replacement Analysis
Old Equipment:
Depreciation expense, Years 1 to 5	$650
Depreciation expense, Year 6	$325
Current book value	$3,575
Current market value	$4,150
Market value, Year 6	$800
New Equipment:
Estimated useful life (in years)	6
Purchase price	$14,000
Salvage value, Year 6	$1,400
Annual sales increase	$2,000
Annual reduction in operating expenses	$1,400
Initial increase in inventories	$2,900
Initial increase in accounts payable	$700
	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
MACRS depreciation rates (5-year class):	20.00%	32.00%	19.20%	11.52%	11.52%	5.76%
Tax rate	40.00%
WACC	15.00%
Step 1: Calculation of investment at t = 0		Formulas
Purchase price of new equipment	-$14,000
Sale of old equipment	$4,150
Tax on sale of old equipment		#N/A
Change in net operating working capital		#N/A
Total investment outlay		#N/A
Step 2: Calculation of annual after-tax cash inflows
Annual sales increase	$2,000
Annual reduction in operating expenses	$1,400
Annual increase in pre-tax revenues		#N/A
After-tax annual revenue increase		#N/A
Step 3: Calculation of annual depreciation tax savings
	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
New equipment
Old equipment	$650	$650	$650	$650	$650	$325
Change in annual depreciation	-$650	-$650	-$650	-$650	-$650	-$325
Annual dpreciation tax savings
Formulas
	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
New equipment	#N/A	#N/A	#N/A	#N/A	#N/A	#N/A
Old equipment	$650	$650	$650	$650	$650	$325
Change in annual depreciation	-$650	-$650	-$650	-$650	-$650	-$325
Annual depreciation tax savings	#N/A	#N/A	#N/A	#N/A	#N/A	#N/A
Step 4: Calculation of net present value of replacement
	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Formulas
Initial investment outlay	$0
Annual after-tax revenue increase		$0	$0	$0	$0	$0	$0
Annual depreciation tax savings		$0	$0	$0	$0	$0	$0
Working capital recovery								#N/A
Salvage value on new equipment							$1,400
Tax on salvage value of new equipment								#N/A
Opportunity cost of old equpment								#N/A
Project cash flows	$0	$0	$0	$0	$0	$0		#N/A
		Formulas
Net present value		#N/A
Should firm replace the old equipment?		#N/A