he Gilbert Instrument Corporation is considering replacing the wood steamer it c
ID: 2717749 • Letter: H
Question
he Gilbert Instrument Corporation is considering replacing the wood steamer it currently uses to shape guitar sides. The steamer, purchased just 2 years ago, is being depreciated on a straight-line basis and has 6 years of remaining life. Its current book value is $1,800, and it can be sold on an Internet auction site for $4,500 at this time. Thus, the annual depreciation expense is $1,800/6=$300 per year. 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 $7,800, and has an estimated useful life of 6 years with an estimated salvage value of $780. 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 $1,600 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 13%. Should it replace the old steamer?
What is the NPV of the project? Round your answer to the nearest dollar.
Explanation / Answer
Incremental NPV is >0 therefore old steamer should be replaced
Time line 0 1 2 3 4 5 6 Cost of new machine -7800 +Proceeds from sale of old machine =selling price* ( 1 -tax rate) 2880 +tax shield on book value =bookvalue*tax rate 720 -increase in working capital =inventory - payables -2200 =Initial Investment outlay -6400 MACR% 20% 32% 19.20% 11.52% 11.52% 5.76% Benefits =sales+(decrease in opex) 3600 3600 3600 3600 3600 3600 -Depreciation Cost of machine*MACR% -1560 -2496 -1497.6 -898.56 -898.56 -449.28 =Pretax cash flows 2040 1104 2102.4 2701.44 2701.44 3150.72 -taxes =(Pretax cash flows)*(1-tax) 1224 662.4 1261.44 1620.864 1620.864 1890.432 +Depreciation 1560 2496 1497.6 898.56 898.56 449.28 =after tax operating cash flow 2784 3158.4 2759.04 2519.424 2519.424 2339.712 reversal of working capital 2200 +Proceeds from sales after tax =salvage value*(1-tax rate) 468 "=Terminal year after tax cash flows 2668 Total Cash flow for the period -6400 2784 3158.4 2759.04 2519.424 2519.424 5007.712 Required rate of return= 13% Discount factor= (1+ required rate)^N 1 1.13 1.2769 1.442897 1.630474 1.842435 2.081952 Discounted cash flow= total cash flow/discount factor -6400 2463.716814 2473.49 1912.153 1545.21 1367.442 2405.297 NPV= Sum of discounted cash flow = 5767.309603Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.