At times firms will need to decide if they want to continue to use their current...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
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. Price Co. is considering replacing an existing piece of equipment. The project involves the following: • The new equipment will have a cost of $600,000, and it is eligible for 100% bonus depreciation so it will be fully depreciated at t = 0. • The old machine was purchased before the new tax law, so it is 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 operating working capital (NOWC) of $60,000 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) will increase by a total of $700,000 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 25%. Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment. Initial investment EBIT - Taxes - A Depreciation x T + Salvage value - Tax on salvage - NOWC + Recapture of NOWC Total free cash flow Year 0 -$450,000 $300,000 $25,000 $60,000 O $2,133,655 O $1,577,049 O $2,226,422 Year 1 $1,855,352 $700,000 The net present value (NPV) of this replacement project is: $12,500 Year 2 $12,500 Year 3 $12,500 Year 4 $12,500 Grade It Now Year 5 $0 Y ▼ Save & Continue Ye $0 A-Z Offic A+ 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. Price Co. is considering replacing an existing piece of equipment. The project involves the following: • The new equipment will have a cost of $600,000, and it is eligible for 100% bonus depreciation so it will be fully depreciated at t = 0. • The old machine was purchased before the new tax law, so it is 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 operating working capital (NOWC) of $60,000 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) will increase by a total of $700,000 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 25%. Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment. Initial investment EBIT - Taxes - A Depreciation x T + Salvage value - Tax on salvage - NOWC + Recapture of NOWC Total free cash flow Year 0 -$450,000 $300,000 $25,000 $60,000 O $2,133,655 O $1,577,049 O $2,226,422 Year 1 $1,855,352 $700,000 The net present value (NPV) of this replacement project is: $12,500 Year 2 $12,500 Year 3 $12,500 Year 4 $12,500 Grade It Now Year 5 $0 Y ▼ Save & Continue Ye $0 A-Z Offic A+
Expert Answer:
Answer rating: 100% (QA)
The detailed answer for the above question is provided below Year 0 Initial Investment 450000 EBIT 7... View the full answer
Related Book For
Concepts in Federal Taxation
ISBN: 9780324379556
19th Edition
Authors: Kevin E. Murphy, Mark Higgins, Tonya K. Flesher
Posted Date:
Students also viewed these finance questions
-
Which type of organizational structure is best for R&D personnel to keep in touch with other researchers?
-
Which type of organization structure is often used by companies that produce standard products? Why?
-
Which type of organizational structure is best suited for developing a new product which requires a high level of specialization in several functions and the time to market represents a critical...
-
You are in the market for a new car and have narrowed your search down to two types: Car X costs $36,300, will last for four years, and will be worth $3,630 at the end of its useful life. It will...
-
Many companies that cater to teenagers have learned that young people respond to commercials that provide dance-beat music, adventure, and a fast pace rather than words. In one test, a group of 128...
-
A linear operator L: V V, where V is an n-dimensional Euclidean space, is called orthogonal if (L(x), L(y)) = (x, y). Let S be an orthonormal basis for V, and let the matrix A represent the...
-
Use stepwise regression to build a model for the home rental prices and home sales data in Table B.24. Perform a residual analysis on the final model. Compare this model to the all possible...
-
Procter Company owns 90% of the outstanding stock of Silex Company. On January 1, 2011, Silex Company sold land to Procter Company for $350,000. Silex had originally purchased the land on June 30,...
-
The density of a fluid changes with depth from the surface h according to the following formula: (h) = ch 2 , where c is a constant. A. What an expression for the gauge pressure p as a function of...
-
Laurens Beauty Boutique has experienced the following weekly sales: Forecast sales for week 6 using the nave method, a simple average, and a three-period moving average. Week 1 2 3 4 5 Sales 420 382...
-
1. A bank borrows $100,000 from the Fed, leaving a $100,000 Treasury bond on deposit with the Fed to serve as collateral for the loan. The discount rate that applies to the loan is 4 percent, and the...
-
How did the Maternity Mortality Ratio change over time for Sri Lanka and Finland? What initiatives were successful in changing the Maternal Mortality Ratio? 2. What are some similarities and/or...
-
You are a consultant for a local nonprofit organization that is concerned about a decline in contributions. This nonprofit provides social services to those who are impacted by poverty. What would...
-
What was the justification given for privatizing prisons in United States?
-
Why do XTO strategies simplify the planning effort for a Master Production Scheduler?
-
What is the relationship between stakeholders and business analysts?
-
ULA V-(0.750 m/s)i A cruise ship with a mass of 107 kg strikes a pier at a speed of 0.750 m/s. After traveling 5.93 meters, damaging the ship and the pler, determine the average force in Newtons...
-
What are the main distinctions between the different schools of legal interpretation?
-
Miriam is a self-employed computer consultant. Her business nets $120,000 annually and she takes $85,000 of the earnings in salary. Miriam is considering incorporating her computer consulting...
-
Discuss how a controlled foreign corporation is taxed.
-
Manuel and Rita sell their home in Minneapolis for $495,000, incurring selling expenses of $25,000. They had purchased the residence for $85,000 and made capital improvements totaling $20,000 during...
-
Management is considering three alternatives to satisfy an urgent need. Each of the alternatives will completely satisfy the need, so no combinations have to be considered. The first costs, operating...
-
Consider the following cash flow profile, and assume MARR is 10 percent/year and the finance rate is 4 percent/year. a. Determine the MIRR for this project. b. Is this project economically...
-
Consider the following cash flow profile and assume MARR is 10 percent/year and the finance rate is 4 percent/ year. a. Determine the MIRR for this project. b. Is this project economically...
Study smarter with the SolutionInn App