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 $1,800,000, and it will be depreciated on a straight-line basis over a period of six years (years 1–6).•The old machine is also 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 $50,000 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 $300,000 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 30%. Year 0Year 1Year 2Year 3Year 4Year 5InitialinvestmentЕBIT- Taxes+ Newdepreciation- Olddepreciation+ Salvagevalue- Tax onsalvage- NOWCRecaptureof NOWCTotal free$510,000cash flow11

Net present value: It is the difference between the present value of cash inflow and the present…

Answered: Year 0 Year 1 Year 2 Year 3 Year 4 Year…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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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 $1,800,000, and it will be depreciated on a straight-line basis over a period of six years (years 1–6).
•	The old machine is also 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 $50,000 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 $300,000 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 30%.

Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Initial
investment
ЕBIT
- Taxes
+ New
depreciation
- Old
depreciation
+ Salvage
value
- Tax on
salvage
- NOWC
Recapture
of NOWC
Total free
$510,000
cash flow
11

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