St. Johns River Shipyards is considering the replacement of an 8-year-old riveting machine with a new one that will increase earnings before depreciationfrom $30,000 to $54,000 per year. The new machine will cost $90,000, and it will have an estimated life of 8 years and no salvage value. The new rivetingmachine is eligible for 100% bonus depreciation at the time purchase. The applicable corporate tax rate is 25%, and the firm's WACC is 16%. The oldmachine has been fully depreciated and has no salvage value.What is the NPV of the project? Negative value, if any, should be indicated by a minus sign. Round your answer to the nearest cent.$Should the old riveting machine be replaced by the new one?-Select-

Concept. Net present value is calculated by deducting initial investment from present value of cash inflows. If net present value is positive , then the project can be accepted. 1. Computation of initial investment. Cost of new machine = $ 90000. Bonus depreciation = 100 % = $ 90000. Tax rate = 25%. Tax savings on bonus depreciation = Bonus depreciation × tax rate = 90000 × 25% = $ 22500. Initial investment =cost - Tax savings on bonus depreciation =90000 - 22500 =$ 67500.2. Computation of annual cash inflows. Earnings from old machine = $ 30000. Earnings from new machine = $ 54000. Incremental earnings = 54000 - 30000 = $24000. Incremental earnings after tax = 24000 × (100%-25%) = $ 18000. Hence , annual cash inflow from year 1 to 8 is $ 18000. Computation of net present value. Life of new machine = 8 years. WACC = 16%. Present value annuity factor (16%, 8 years) = 4.3436. Annual cash inflow = $ 18000. Present value of cash inflows = 18000 × 4.3436 =$ 78184.8 Initial investment = $ 67500. Net present value = 78184.8 - 67500 = 10684.8 = 10685.( rounded off). Net present value is $ 10685. Net present value is positive. Hence , REPLACE old machine.

Answered: St. Johns River Shipyards is…

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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