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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

REPLACEMENT ANALYSIS Mississippi River Shipyards is considering the replacement of an 8-year-old riveting machine with a new one that will increase earnings before depreciation from $27,000 to $54,000 per year. The new machine will cost $82,500, and it will have an estimated life of 8 years and no salvage value. The new machine will be depreciated over its 5-year MACRS recovery period; so the applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. The applicable corporate tax rate is 40%, and the firm’s WACC is 12%. The old machine has been fully depreciated and has no salvage value. Should the old riveting machine be replaced by the new one? Explain your answer.

Summary Introduction

To explain: Whether the proposal of a new machine accept or not

Replacement Analysis:

The analysis of the replacement of assets of the company is the replacement analysis. To reduce the cost of the company, management take decision to replace the existing asset. The incremental cash flow is calculated while taking replacement decision.

Net present Value (NPV):

NPV is the technique of capital budgeting. To select the project or not is dependent on the NPV of the project. If the project has positive NPV than accept the project, if the NPV is negative than reject the project.

Explanation

Life of old machine 8years

New machine increase the earnings before depreciation from $27,000 to $54,000 per year

The cost of new machine is $ 82,500

Life of machine is 8 years

No salvage value

5 year MACRS depreciation rate are, 20%, 32%, 19%, 12%, 11%, and 6%.

Tax rate 40%

WACC is 12 %

Table (1)

Increase in income,

Increase in income=$54,000$27,000=$27,000

Year

Annual Cash flows

($)

(A)

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