4. Replacement decision. The electronics company is deciding if the manually ope

Question

4. Replacement decision. The electronics company is deciding if the manually operated equipment should be replaced by fully automatic equipment. You have the following information Current situation Two workers with the salary 20 000 USD per year per one worker Maintenance cost is 10 000 USD per year Waste (e.g. defective work) is 12 000USD per year Economic lifetime of the machinery 10 vears (investment was made 5 years ago) Salvage value is 0. (e.g. book value in 5 years, also market value is zero) Linear depreciation method (8 000 per year) Current market value if sold 24 000USD Tax rate 34% on EBT New project Investment (new machinery) 120 000USD Two workers salary is saved Maintenance cost is 15 000USD Waste: 6 000USD per year Economic lifetime 5 years Linear depreciation method Book value market value in five years. (both book and market values are 0) Required rate of return is 12% Should the company replace the existing machinery? Your task is to prepare the cash flow budget and evaluate the project, based on NPV

Explanation / Answer

NPV of current project = -$137703.36

NPV of replacing project = -$21380.64

Since NPV of replacing project is higher than that of current project, the project should be replaced.

NPV of Current Project: Years 1 to 5 Workers' salary (20000*2) -40000 Maintenance Cost -10000 Waste -12000 Depreciation -8000 EBT -70000 Taxes (34%) -23800 EAT -46200 Depreciation 8000 Cash Flow after tax -38200 PVAF (12%, 5) 3.6048 PV of Cash Flows -137703.36 NPV of Replacing project: Year 0 Years 1 to 5 Cost of investment -120000 Market value of current project 24000 Net cost of investment -96000 Savings in workers' salary 40000 Maintenance cost -15000 Waste -6000 Depreciation (120000/5) -24000 EBT -5000 Taxes (34%) -1700 EAT -3300 Depreciation 24000 Cash Flow after tax 20700 PVAF (12%, 5) 3.6048 PV of Cash Flows -96000 74619.36 NPV of Replacing project -21380.64

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