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 $2,400,000, and it is eligible for 100% bonus depreciation so it will be fully depreciated at t=0. • The old machine was purchased before the new tax law, so it is 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 operating working capital (NOWC) of $30,000 that will be recovered at the end of the project's life (year 6). • The new machine is more efficient, so the firm's incremental earnings before interest and taxes (EBIT) will increase by a total of $400,000 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 25%. Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment. Initial investment EBIT - Taxes -A Depreciation XT + Salvage value - Tax on salvage - NOWC Recapture of NOWC Total free cash flow Year 0 -$283,880 O-$454,207 Year 1 The net present value (NPV) of this replacement project is: -$435,282 -$378,506 Year 2 Year 3 Year 4 Year 5
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 $2,400,000, and it is eligible for 100% bonus depreciation so it will be fully depreciated at t=0. • The old machine was purchased before the new tax law, so it is 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 operating working capital (NOWC) of $30,000 that will be recovered at the end of the project's life (year 6). • The new machine is more efficient, so the firm's incremental earnings before interest and taxes (EBIT) will increase by a total of $400,000 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 25%. Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment. Initial investment EBIT - Taxes -A Depreciation XT + Salvage value - Tax on salvage - NOWC Recapture of NOWC Total free cash flow Year 0 -$283,880 O-$454,207 Year 1 The net present value (NPV) of this replacement project is: -$435,282 -$378,506 Year 2 Year 3 Year 4 Year 5
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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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 $2,400,000, and it is eligible for 100% bonus |
| • | The old machine was purchased before the new tax law, so it is 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 operating working capital (NOWC) of $30,000 that will be recovered at the end of the project's life (year 6). |
| • | The new machine is more efficient, so the firm’s incremental earnings before interest and taxes (EBIT) will increase by a total of $400,000 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 25%. |
*There is a spot for Year 6 as well.
Transcribed Image Text: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 $2,400,000, and it is eligible for 100% bonus depreciation so it will be fully depreciated at
t = 0.
• The old machine was purchased before the new tax law, so it is 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 operating working capital (NOWC) of $30,000 that will be recovered at the
end of the project's life (year 6).
• The new machine is more efficient, so the firm's incremental earnings before interest and taxes (EBIT) will increase by a total of
$400,000 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 25%.
Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment.
Initial
investment
EBIT
- Taxes
-A
Depreciation
x T
+ Salvage
value
- Tax on
salvage
- NOWC
Recapture
of NOWC
Total free
cash flow
Year 0
-$435,282
O -$378,506
O-$283,880
O -$454,207
Year 1
The net present value (NPV) of this replacement project is:
Year 2
Year 3
Year 4
Year 5
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