The managers of Price Company are considering replacing an existing piece of equipment, and have collected the following information: • The new piece of equipment will have a cost of $600,000, and it will be depreciated on a straight-line basis over a period of five years. • The old machine is also being depreciated on a straight-line basis. It has a book value of $200,000 (at year 0) and three 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 5). The old machine has a current salvage value (at year 0) of $300,000. • Replacing the old machine will require an investment in net working capital (NWC) of $20,000 that will be recovered at the end of the project's life (year 5). • The new machine is more efficient, so the incremental increase in operating income before taxes will increase by a total of $500,000 in each of the next five years (years 1-5). (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 required rate of return is 9%. • The company's annual tax rate is 35%. Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment. Initial investment Oper. inc. before tax Taxes New depreciation Old depreciation Net salvage value Net working capital Return of net working capital Total net cash flow ( Year 0 Year 1 The net present value (NPV) of this replacement project is Year 2 Year 3 Year 4 $445,000 Year 5 $500,000
The managers of Price Company are considering replacing an existing piece of equipment, and have collected the following information: • The new piece of equipment will have a cost of $600,000, and it will be depreciated on a straight-line basis over a period of five years. • The old machine is also being depreciated on a straight-line basis. It has a book value of $200,000 (at year 0) and three 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 5). The old machine has a current salvage value (at year 0) of $300,000. • Replacing the old machine will require an investment in net working capital (NWC) of $20,000 that will be recovered at the end of the project's life (year 5). • The new machine is more efficient, so the incremental increase in operating income before taxes will increase by a total of $500,000 in each of the next five years (years 1-5). (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 required rate of return is 9%. • The company's annual tax rate is 35%. Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment. Initial investment Oper. inc. before tax Taxes New depreciation Old depreciation Net salvage value Net working capital Return of net working capital Total net cash flow ( Year 0 Year 1 The net present value (NPV) of this replacement project is Year 2 Year 3 Year 4 $445,000 Year 5 $500,000
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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I need help analyzing this replacement project.
Transcribed Image Text:The managers of Price Company are considering replacing an existing piece of equipment, and have collected the following information:
• The new piece of equipment will have a cost of $600,000, and it will be depreciated on a straight-line basis over a period of five years.
• The old machine is also being depreciated on a straight-line basis. It has a book value of $200,000 (at year 0) and three 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 5). The old machine has a current salvage
value (at year 0) of $300,000.
• Replacing the old machine will require an investment in net working capital (NWC) of $20,000 that will be recovered at the end of the
project's life (year 5).
• The new machine is more efficient, so the incremental increase in operating income before taxes will increase by a total of $500,000
in each of the next five years (years 1-5). (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 required rate of return is 9%.
• The company's annual tax rate is 35%.
Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment.
Initial investment
Oper. inc. before tax
Taxes
New depreciation
Old depreciation
Net salvage value
Net working capital
Return of net working
capital
Total net cash flow
Year 0
Year 1
The net present value (NPV) of this replacement project is
Year 2
Year 3
Year 4
$445,000
Year 5
$500,000
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