REPLACEMENT ANALYSIS St. Johns River Shipyards is considering the replacement of

Question

REPLACEMENT ANALYSIS St. Johns River Shipyards is considering the replacement of an 8-year-old riveting machine with a new one that will increase earnings before depreciation from $30,000 to $46,000 per year. The new machine will cost $80,000, and it will have an estimated life of 8 years and no salvage value. The new machine will be depreciated over its 5-year MACRS recovery period, so the applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. The applicable corporate tax rate is 40%, and the firm's WACC is 14%. The old machine has been fully depreciated and has no salvage value. What is the NPV of the project? Round your answer to the nearest cent. Negative amount should be indicated by a minus sign. Should the old riveting machine be replaced by the new one? Yes

Explanation / Answer

NPV analysis should include only the increase in earnings before depreciation, which is the benefit of new machine.

Depreciation = Investment x MACRS (%)

Cash Flows = Investment + Profits + Depreciation

NPV can be calculated using NPV function on a calculator or excel or using formula with 14% WACC.

We get NPV = $1,336.85

As NPV > 0, old machine should be replaced with new one.

0 1 2 3 4 5 6 7 8 MACRS % 20% 32% 19% 12% 11% 6% Investment -80,000 Inc. in Earnings 16,000 16,000 16,000 16,000 16,000 16,000 16,000 16,000 Depreciation -16,000 -25,600 -15,200 -9,600 -8,800 -4,800 0 0 EBT 0 -9,600 800 6,400 7,200 11,200 16,000 16,000 Tax (40%) 0 3,840 -320 -2,560 -2,880 -4,480 -6,400 -6,400 Profits 0 -13,440 1,120 8,960 10,080 15,680 22,400 22,400 Cash Flows -80,000 16,000 12,160 16,320 18,560 18,880 20,480 22,400 22,400 NPV $1,336.85

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