Hi, can you please solve this :) Thank you!! 4. Analysis of a replacement projec
ID: 2735842 • Letter: H
Question
Hi, can you please solve this :) Thank you!!
4. Analysis of a replacement project Aa Aa E 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 $1,800,000, and it will be depreciated on a straight-line basis over a period of six years (years 1-6) The old machine is also 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 working capital (NWC) of $20,000 that will be recovered at the end of the project's life (year 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 40%. Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment.Explanation / Answer
Answer-
year 0
year 1
year 2
year 3
year 4
year 5
year 6
Initial investment
-1800000
EBIT
700000
700000
700000
700000
700000
700000
- Taxes (40%)
-280000
-280000
-280000
-280000
-280000
-280000
+ New depreciation
300000
300000
300000
300000
300000
300000
- Old depreciation
-50000
-50000
-50000
-50000
+ Salvage Value
300000
- Tax on salvage
-40000
- NWC
-20000
+ Recapture of NWC
20000
Total free cash flow
-1560000
670000
670000
670000
670000
720000
740000
PVF@13%
1
0.884
0.783
0.693
0.613
0.543
0.480
Present value
-1560000
592950
524610
464310
410710
390960
355200
Net present value= $1178740 (sum of all present value)
(the difference in NPV from the answer II is due to rounding off the present value factor)
year 0
year 1
year 2
year 3
year 4
year 5
year 6
Initial investment
-1800000
EBIT
700000
700000
700000
700000
700000
700000
- Taxes (40%)
-280000
-280000
-280000
-280000
-280000
-280000
+ New depreciation
300000
300000
300000
300000
300000
300000
- Old depreciation
-50000
-50000
-50000
-50000
+ Salvage Value
300000
- Tax on salvage
-40000
- NWC
-20000
+ Recapture of NWC
20000
Total free cash flow
-1560000
670000
670000
670000
670000
720000
740000
PVF@13%
1
0.884
0.783
0.693
0.613
0.543
0.480
Present value
-1560000
592950
524610
464310
410710
390960
355200
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