The old machine is also being depreciated on a straight-line basis. It has a book value...
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The old machine is also being depreciated on a straight-line basis. It has a book value of $200,000 (at year 0) and three 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 5). 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 5). The new machine is more efficient, so the incremental increase in earnings before interest and taxes (EBIT) will increase by a total of $700,000 in each of the next five years (years 1-5). (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 required rate of return is 10%. The company's annual tax rate is 35%. 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 Initial investment EBIT $700,000 Less: Taxes Plus: New depreciation Less: Old depreciation Plus: Salvage value Less: Tax on salvage Less: NWC Plus: Recapture of NWC Total Net Cash Flow The net present value (NPV) of this replacement project is $575,000 The old machine is also being depreciated on a straight-line basis. It has a book value of $200,000 (at year 0) and three 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 5). 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 5). The new machine is more efficient, so the incremental increase in earnings before interest and taxes (EBIT) will increase by a total of $700,000 in each of the next five years (years 1-5). (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 required rate of return is 10%. The company's annual tax rate is 35%. 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 Initial investment EBIT $700,000 Less: Taxes Plus: New depreciation Less: Old depreciation Plus: Salvage value Less: Tax on salvage Less: NWC Plus: Recapture of NWC Total Net Cash Flow The net present value (NPV) of this replacement project is $575,000
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