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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

REPLACEMENT ANALYSIS The Darlington Equipment Company purchased a machine 5 years ago at a cost of $85,000. 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 $8,500 per year. If the machine is not replaced, it can be sold for $15,000 at the end of its useful life.

A new machine can be purchased for $170,000, including installation costs. During its 5-year life, it will reduce cash operating expenses by $40,000 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 40%. The appropriate WACC is 9%.

  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 Darlington replace the old machine? Explain.

a.

Summary Introduction

To Determine: The initial cash flow at year 0 if the new machine is purchased.

Introduction: The net present value is also termed as the discounted cash flow approach is a mainstream capital budget method that considers the time value of cash. It utilizes net present value of the investment as the base to accept or reject a projected investment in projects like buying of new machine, buying of stock or inventory etc.

Explanation

Determine the initial cash flow at year 0 if the new machine is purchased

Using a excel spreadsheet, the initial cash flow at year 0 if the new machine is purchased is determined as -$120,000.

Excel Spreadsheet:

b.

Summary Introduction

To Determine: The incremental cash flows from year 1 to 5.

c.

Summary Introduction

To Determine: The net present value of the project and whether Company DE should replace the old machine.

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