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REPLACEMENT ANALYSIS The Erley 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 $10,000 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 $50,000 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 $55,000. The firm’s tax rate is 35%. The appropriate WACC is 16%. a. If the new machine is purchased, what is the amount of the initial cash flow at Year 0? b. What are the incremental cash flows that will occur at the end of Years 1 through 5? c. What is the NPV of this project? Should Erley replace the old machine? Explain.

BuyFind

Fundamentals of Financial Manageme...

8th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781285065137
BuyFind

Fundamentals of Financial Manageme...

8th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781285065137

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Chapter
Section
Chapter 12, Problem 15P
Textbook Problem

REPLACEMENT ANALYSIS The Erley 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 $10,000 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 $50,000 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 $55,000. The firm’s tax rate is 35%. The appropriate WACC is 16%.

  1. a. If the new machine is purchased, what is the amount of the initial cash flow at Year 0?
  2. b. What are the incremental cash flows that will occur at the end of Years 1 through 5?
  3. c. What is the NPV of this project? Should Erley replace the old machine? Explain.

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Chapter 12 Solutions

Fundamentals of Financial Management, Concise Edition (with Thomson ONE - Business School Edition, 1 term (6 months) Printed Access Card) (MindTap Course List)
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