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Homework answers / question archive / The new piece of equipment will have a cost of $1,200,000, and it will be depreciated on a straight-line basis over a period of five years (years 1–5)

The new piece of equipment will have a cost of $1,200,000, and it will be depreciated on a straight-line basis over a period of five years (years 1–5)

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The new piece of equipment will have a cost of $1,200,000, and it will be depreciated on a straight-line basis over a period of five years (years 1–5).
• 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 earnings before interest and taxes (EBIT) 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 12%.
• 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.

 

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5
Initial investment $1,200,000             
EBIT               $500,000
Less: Taxes                 
Plus: New depreciation                 
Less: Old depreciation               
Plus: Salvage value             
Less: Tax on salvage             
Less: NWC             
Plus: Recapture of NWC             
Total Net Cash Flow             $565,000   

The net present value (NPV) of this replacement project is   

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