St. Johns River Shipyards\'s welding machine is 15 years old, fully depreciated,

Question

St. Johns River Shipyards's welding machine is 15 years old, fully depreciated, obsolete, and has no salvage value. However, even though it is obsolete, it is perfectly functional as originally designed and can be used for quite a while longer. The new welder will cost $81,000, and have an estimated life of 8 years with no salvage value. The new welder will be much more efficient, however, and this enhanced efficiency will increase earnings before depreciation from $28,000 to $56,000 per year. The new machine will be depreciated over its 5-year MACRS recovery period, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The applicable corporate tax rate is 40%, and the firm's WACC is 11%. Should the old welder be replaced by the new one?
a) should or should not be replaced
b)What is the NPV of the project? Round your answer to the nearest cent.

Explanation / Answer

Soln:

By comparing the present value of cash flows from old welder to new welder, it is advisable to continue with the old welder.

The present values of the project are as follows:

The Present value of Old welder =  $ 86,469.60

The Present value of new welder =  50,634.59

The cash flows from old machine assuming it can run for another 8 years Operating cash flow from old machine = $ 28,000 X (1- tax rate) OCF from old machine = 16,800 year cash flows from old M/C Discount rate Present value of cash flows 1 16,800 0.901 15136.8 2 16,800 0.812 13641.6 3 16,800 0.731 12280.8 4 16,800 0.659 11071.2 5 16,800 0.593 9962.4 6 16,800 0.535 8988 7 16,800 0.482 8097.6 8 16,800 0.434 7291.2 86469.6 Depreciation schedule of the new machine year rate value 1 20.00% 16,200 2 32.00% 25,920 3 19.20% 15,552 4 11.52% 9,331.20 5 11.52% 9,331.20 6 5.76% 4,665.60 7 Straight line depreciation 10,125.00 8 Straight line depreciation 10,125.00 operating cash flow from new machine year cash flows OCF discount rate present value of cash flows 0 -81,000 1 (56,000 - 16,200) X 0.60 = 23880 23,880 0.901 21515.88 2 (56,000 - 25,920)X0.6 19,248 0.812 15629.376 3 (56,000 - 15,552)X0.6 24,268.80 0.731 17740.4928 4 (56,000 - 9331.20)X0.6 28,001.28 0.659 18452.84352 5 (56,000 - 9331.20)X0.6 28,001.28 0.593 16604.75904 6 (56,000 - 4665.60)X0.6 30800.64 0.535 16478.3424 7 (56,000 - 10,125)X0.6 27,525 0.482 13267.05 8 (56,000 - 10,125)X0.6 27,525 0.434 11945.85 131634.5938 Net present value = -81,000+131634.59 NPVof new machine = 50,634.59 Present value of cash flows from old machine = $ 86,469.60

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