The Gilbert Instrument Corporation is considering replacing the wood steamer it

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 12%. Should it replace the old steamer?

The old steamer _________(answer choices: should/should not) be replaced.

What is the NPV of the project?

Explanation / Answer

Solution:

To compute the NPV of the new steamer and if the new steamer NPv is positive then we can arrive at the Present value of keeping the old steamer but if the new steamer NPV is negative then no point in buying the new steamer :

Cash flow benefits would be :

NPV of the new steamer is :

Since the net present value is negative for new steamer hence should not be replaced.

Particulars/Formula NEw steamer cash flow Total sales (unit sold*price) 2000 2000 2000 2000 2000 2000 Variable cost(300* units) 1500 1500 1500 1500 1500 1500 Gross profit 500 500 500 500 500 500 Depreciation at given MACRS rate 20% 32% 19.20% 11.52% 11.52% 5.76% Depreciation 1600 2560 1536 921.6 921.6 460.8 Profit -1100 -2060 -1036 -421.6 -421.6 39.2 Tax 40% -440 -824 -414.4 -168.64 -168.64 15.68 Profit after tax -660 -1236 -621.6 -252.96 -252.96 23.52 CAsh flows = profit+depreciation 940 1324 914.4 668.64 668.64 484.32

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