The new equipment will have a cost of $1,200,000, 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 so 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 $20,000 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 $700,000 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%

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
icon
Related questions
Question
y Tools
Tips
Tips
Attempts 9
4. Analysis of a replacement project
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 plece of equipment. The project involves the following:
Average/2
• The new equipment will have a cost of $1,200,000, 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 10 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 $20,000 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
$700,000 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
Year 0
Year 1
Year 2
Year 3-
Year 4
<<
Year 5
Transcribed Image Text:y Tools Tips Tips Attempts 9 4. Analysis of a replacement project 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 plece of equipment. The project involves the following: Average/2 • The new equipment will have a cost of $1,200,000, 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 10 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 $20,000 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 $700,000 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 Year 0 Year 1 Year 2 Year 3- Year 4 << Year 5
Tips
Tips
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
ET
+Salvage
value
-Taxon
salvage
-NOWC
Recapture
of NOWC
Total free
cash flow
Year O
The net present value (NPV) of this replacement project is
$1,212,218
$1,426,139
O $1.440,000
Year 1
11,065,604
Year 2
Year 3
Year 4
Year 5
Transcribed Image Text:Tips Tips 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 ET +Salvage value -Taxon salvage -NOWC Recapture of NOWC Total free cash flow Year O The net present value (NPV) of this replacement project is $1,212,218 $1,426,139 O $1.440,000 Year 1 11,065,604 Year 2 Year 3 Year 4 Year 5
Expert Solution
trending now

Trending now

This is a popular solution!

steps

Step by step

Solved in 3 steps with 2 images

Blurred answer
Knowledge Booster
Present Value
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.
Similar questions
  • SEE MORE QUESTIONS
Recommended textbooks for you
Essentials Of Investments
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
FUNDAMENTALS OF CORPORATE FINANCE
FUNDAMENTALS OF CORPORATE FINANCE
Finance
ISBN:
9781260013962
Author:
BREALEY
Publisher:
RENT MCG
Financial Management: Theory & Practice
Financial Management: Theory & Practice
Finance
ISBN:
9781337909730
Author:
Brigham
Publisher:
Cengage
Foundations Of Finance
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education