The Gilbert Instrument Corporation is considering replacing the wood steamer it
ID: 2720363 • Letter: T
Question
The 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 $2,400, and it can be sold on an Internet auction site for $4,500 at this time. Thus, the annual depreciation expense is $2,400/6=$400 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 $8,000, and has an estimated useful life of 6 years with an estimated salvage value of $800. 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 $1,500 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%. Should it replace the old steamer?
The old steamer -Select-shouldshould notItem 1 be replaced.
What is the NPV of the project? Round your answer to the nearest dollar.
$
Explanation / Answer
Ans
Workings
Details Amount Amount Initial Cost 8,000.00 Less Residual Value of Old machine -4,500.00 Book Value 2,400.00 2,100.00 Less Capital Gain tax 840.00 Net residual Value -3,660.00 Additional Working Capital=(Inventory-Accounts Payable) 2,200.00 Net Initial Cost -6,540.00 Incremental Annual Operating cash flows Increase in sales 2,000.00 Reduction in operating cost 1,500.00 Incremental operating cash flows 3,500.00 Less tax 40% 1,400.00 Incremental annual operating cash flows net off tax 2,100.00 PVAF of 15% for 6 years 3.78 Present Value of Incremental annual cash flows net off tax 7,947.41 Incremental Depreciation Tax Shied 3,060.49 Incremental Residual Value - Tax Outlow on Residual Value 800*.40 -320.00 Incremental NPV 4,147.91 Old machine should be replacedWorkings
Opening Book Value MACRS Dep Rates Dep Amount Tax Shield (1-.4) DF Savings in cash flow 8000 20% 1,600.00 960.00 0.87 834.78 32% 2,560.00 1,536.00 0.76 1,161.44 19.20% 1,536.00 921.60 0.66 605.97 11.52% 921.60 552.96 0.57 316.16 11.52% 921.60 552.96 0.50 274.92 5.76% 460.80 276.48 0.43 119.53 3,312.79 Opening Book Value Dep Rates Dep Amount Tax Shield (1-.4) DF Savings in cash flow 2400 16.67% 400.00 66.67 0.87 57.97 16.67% 400.00 66.67 0.76 50.41 16.67% 400.00 66.67 0.66 43.83 16.67% 400.00 66.67 0.57 38.12 16.67% 400.00 66.67 0.50 33.15 16.67% 400.00 66.67 0.43 28.82 3.78 252.30 Net Savings in cash flow 3,060.49Related Questions
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