A company is considering replacing an old piece of equipment that is completely depreciated. One possible replacement (machine #1) has a cost of $190,000, an expected 3-year life, and positive after-tax cash flows of $87,000 per year. The other replacement (machine #2) being considered has a cost of $360,000, an expected 6-year life and positive after-tax cash flows of $98,300 per year. Assume that the company's WACC is 14%. Use a calculator and show keystrokes used.
Question 1: Find the NPV of each machine. Check figure: NPV of machine #2 = $22,256.
Question 2: Using the replacement chain approach, find the extended NPV of machine #1. Check figure: Extended NPV of machine #1 = $20,070.
Question 3: Using the equivalent annual annuity (EAA) approach, find the EAA of each machine. Check figure: EAA of machine #1 = $5,161.02.
Question 4: Assuming that both projects can be repeated, which machine should be selected to replace the old equipment? Why?
A company is considering replacing an old piece of equipment that is completely depreciated. One possible replacement (machine #1) has a cost of $190,000, an expected 3-year life, and positive after-tax cash flows of $87,000 per year. The other replacement (machine #2) being considered has a cost of $360,000, an expected 6-year life and positive after-tax cash flows of $98,300 per year. Assume that the company's WACC is 14%. Use a calculator and show keystrokes used.
Question 1: Find the NPV of each machine. Check figure: NPV of machine #2 = $22,256.
Question 2: Using the replacement chain approach, find the extended NPV of machine #1. Check figure: Extended NPV of machine #1 = $20,070.
Question 3: Using the equivalent annual annuity (EAA) approach, find the EAA of each machine. Check figure: EAA of machine #1 = $5,161.02.
Question 4: Assuming that both projects can be repeated, which machine should be selected to replace the old equipment? Why?
Related questions
Replacement analysis
The Darlington Equipment Company purchased a machine 5 years ago at a cost of $90,000. The machine had an expected life of 10 years at the time of purchase, and it is being depreciated by the straight-line method by $9,000 per year. If the machine is not replaced, it can be sold for $5,000 at the end of its useful life.
A new machine can be purchased for $150,000, including installation costs. During its 5-year life, it will reduce cash operating expenses by $60,000 per year. Sales are not expected to change. At the end of its useful life, the machine is estimated to be worthless. MACRS depreciation will be used, and the machine will be depreciated over its 3-year class life rather than its 5-year economic life; so the applicable depreciation rates are 33%, 45%, 15%, and 7%.
The old machine can be sold today for $50,000. The firm's tax rate is 40%. The appropriate WACC is 9%.
If the new machine is purchased, what is the amount of the initial cash flow at Year 0? Round your answer to the nearest dollar. Negative amount should be indicated by a minus sign.
$
What are the incremental net cash flows that will occur at the end of Years 1 through 5? Round your answers to the nearest dollar.
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
| $ | $ | $ | $ | $ |
What is the NPV of this project? Round your answer to the nearest cent. Negative amount should be indicated by a minus sign.
$
Should Darlington replace the old machine?
Replacement analysis
The Bigbee Bottling Company is contemplating the replacement of one of its bottling machines with a newer and more efficient one. The old machine has a book value of $600,000 and a remaining useful life of 5 years. The firm does not expect to realize any return from scrapping the old machine in 5 years, but it can sell it now to another firm in the industry for $295,000. The old machine is being depreciated by $120,000 per year, using the straight-line method.
The new machine has a purchase price of $1,175,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $150,000. The applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. It is expected to economize on electric power usage, labor, and repair costs, as well as to reduce the number of defective bottles. In total, an annual savings of $220,000 will be realized if the new machine is installed. The company's marginal tax rate is 35%, and it has a 12% WACC.
What initial cash outlay is required for the new machine? Round your answer to the nearest dollar. Negative amount should be indicated by a minus sign.
$
Calculate the annual depreciation allowances for both machines and compute the change in the annual depreciation expense if the replacement is made. Round your answers to the nearest dollar.
| Year | Depreciation Allowance, New | Depreciation Allowance, Old | Change in Depreciation |
| 1 | $ | $ | $ |
| 2 | $ | $ | $ |
| 3 | $ | $ | $ |
| 4 | $ | $ | $ |
| 5 | $ | $ | $ |
What are the incremental net cash flows in Years 1 through 5? Round your answers to the nearest dollar.
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
| $ | $ | $ | $ | $ |
Should the firm purchase the new machine?
Replacement analysis
The Bigbee Bottling Company is contemplating the replacement of one of its bottling machines with a newer and more efficient one. The old machine has a book value of $600,000 and a remaining useful life of 5 years. The firm does not expect to realize any return from scrapping the old machine in 5 years, but it can sell it now to another firm in the industry for $265,000. The old machine is being depreciated by $120,000 per year, using the straight-line method.
The new machine has a purchase price of $1,200,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $125,000. The applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. It is expected to economize on electric power usage, labor, and repair costs, as well as to reduce the number of defective bottles. In total, an annual savings of $200,000 will be realized if the new machine is installed. The company's marginal tax rate is 35%, and it has a 12% WACC.
What initial cash outlay is required for the new machine? Round your answer to the nearest dollar. Negative amount should be indicated by a minus sign.
$________
Calculate the annual depreciation allowances for both machines and compute the change in the annual depreciation expense if the replacement is made. Round your answers to the nearest dollar.
| Year | Depreciation Allowance, New | Depreciation Allowance, Old | Change in Depreciation |
| 1 | $_______ | $______ | $______ |
| 2 | $_______ | $______ | $______ |
| 3 | $_______ | $______ | $______ |
| 4 | $_______ | $______ | $______ |
| 5 | $_______ | $______ | $______ |
What are the incremental net cash flows in Years 1 through 5? Round your answers to the nearest dollar.
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 |
| $______ | $ ______ | $______ | $_______ | $______ |
