The Erley Equipment Company purchased a machine 5 years ago at a cost of $80,000
ID: 2752383 • Letter: T
Question
The Erley Equipment Company purchased a machine 5 years ago at a cost of $80,000. The machine had an expected life of 10 years at the time of purchase, and it is being depreciated by the straight-line method by $8,000 per year. If the machine is not replaced, it can be sold for $15,000 at the end of its useful life. A new machine can be purchased for $180,000, including installation costs. During its 5-year life, it will reduce cash operating expenses by $45,000 per year. Sales are not expected to change. At the end of its useful life, the machine is estimated to be worthless. MACRS depreciation will be used, and the machine will be depreciated over its 3-year class life rather than its 5-year economic life; so the applicable depreciation rates are 33%, 45%, 15%, and 7%. The old machine can be sold today for $55,000. The firm's tax rate is 35%. The appropriate WACC is 16%.
a. If the new machine is purchased, what is the amount of the initial cash flow at Year 0? Round your answer to the nearest dollar.
b. What are the incremental net cash flows that will occur at the end of Years 1 through 5? Round your answers to the nearest dollar
c. What is the NPV of this project? Round your answer to the nearest cent.
Explanation / Answer
a. If the new machine is purchased, the amount of the initial cash flow at Year 0 =
New machine can be purchased ( including installation costs ) = $180,000,
Less- sale of old machine (net of tax) = 49750
the amount of the initial cash flow at Year 0 = 130250
if machine is replaced and old machine is old at end of 5th year
Sale of old machine = $55,000
Less- WDV value = 40,000
gain on sale = 15,000
Tax on gain on sale @35% = 5250
sale of old machine (net of tax) = 49750
b. Incremental net cash flows that will occur at the end of Years 1 through 5 =
Particulars
Year 1
Year 2
Year 3
Year 4
Year 5
Net annual cash flows from saving of operating cost (a)
$ 45000
$ 45000
$ 45000
$ 45000
$ 45000
Less- depreciation
$ 51400
46270
1950
(8000)
(8000)
Annual savings of operating cost
5400
1270
43050
53000
53000
Less- tax @35% (b)
1890
444.5
15067.5
18550
18550
Cash flow after tax (a-b)
43110
44555.5
29932.5
26450
26450
Add- scrapped value (net of tax)
19733
9750
Net annual cash flow
43100
44555.5
49665.5
26450
36200
Present value factor
.862
.743
.641
.552
.476
PV of cash inflow
37152.2
33105
31836
14600
17231.2
old new
sale of equipment 15000 0
WDV 0 56380
Net gain 15000 (56380)
Tax @35% 5250 ( 19733)
scrap value (net of tax) 9750 19733
Depreciation (old equipment) Depreciation (new equipment) incremental cash flow
8000 59400 (51400)
8000 54270 ( 46270)
8000 9950 (1950)
8000 8000
8000 8000
c) The NPV of this project = Present value of cash inflow - present value of cash outflow
= 133924.4 - 130250
=3674.4
Particulars
Year 1
Year 2
Year 3
Year 4
Year 5
Net annual cash flows from saving of operating cost (a)
$ 45000
$ 45000
$ 45000
$ 45000
$ 45000
Less- depreciation
$ 51400
46270
1950
(8000)
(8000)
Annual savings of operating cost
5400
1270
43050
53000
53000
Less- tax @35% (b)
1890
444.5
15067.5
18550
18550
Cash flow after tax (a-b)
43110
44555.5
29932.5
26450
26450
Add- scrapped value (net of tax)
19733
9750
Net annual cash flow
43100
44555.5
49665.5
26450
36200
Present value factor
.862
.743
.641
.552
.476
PV of cash inflow
37152.2
33105
31836
14600
17231.2
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