Question

please use excel to answer the questions and show all outputs

E3) The Erley Equipment Company purchased a machine 5 years ago at a cost of $100,000. The machine had an expected life of 10 years at the time of purchase, and an expected salvage value of $10,000 at the end of the 10 years. It is being depreciated by the straight line method toward a salvage value of $10,000, or by $9,000 per year. A new machine can be purchased for $150,000, including installation costs. During its 5-year life, it will reduce 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. The old machine can be sold today for $65,000. The firm's tax rate is 35%. The appropriate discount rate is 16%. (The MACRS recovery allowance percentages are specified in the formula sheet as well as at the end of the homework.) a) If the new machine is purchased, what is the amount of the initial cash flow at Year 0? What incremental operating cash flows will occur at the end of Years 1 through 5 as a result of replacing the old machine? What incremental non-operating cash flow will occur at the end of Year 5 if the new machine is purchased? d) What is the NPV of this project? Should Erley replace the old machine? MACRS - Recovery Allowance Percentage for Property Class of Investment Year 3-Year 7-Year 5-Year 20% 10-Year 10% 33% 14% 32

Answer 1

Answer :

a) If new machine is purchased, the amount of the initial cash flow at Year 0 be $ 85,000

( $ 150000 spent for new machine - $ 65000 recovered from sale of old machine )

b ) Incremental Operating Cash flow will occur at end of Year 1 to 5 due to replacing old machine be

1. $ 50,000 cost saving in Operating Expenses

2. Gain on Sale of Old Machine = Cost of Old Machine - Depreciation for 5 years - Sale value of Old Machine = $ 100,000 - ( $ 9,000 x 5 Years ) - $ 65,000 = $ 10,000

c ) Incremental non Operating Cash flow will occur at end of Year 5 if the new machine is purchased :

1. Tax shield on Depreciation of Old Machine = $ 9,000 x 35% = $ 3,150 every year

d) NPV of this Project :

Year	Particulars	Amount $	Discounted factor @ 16%	Discounted Cash Flow
0	Purchase Of Old Machine	- 100,000	1	- 100,000
End of 5 the Year	New Machine Purchased	-150,000	0.4761	= 0.4761 x - 150000 = -71,415
End of 5 th Year	Sale of Old Machine	65,000	0.4761	= 0.4761 X 65,000 = 30,946.50
6-10	Savings in Operating Costs	50,000	1.5589	= 1.5589 X 50,000 = 77,946.69
6	Tax Shield on Depreciation on New Machine	= 150,000 X 33% X 35% = 17,325	0.4104	=17,325 X 0.4104 = 7,110.18
7	Tax Shield on Depreciation on New Machine	=150,000 X 45% X 35% = 23,625	0.3538	= 23,625, X 0.3538 = 8,358.53
8	Tax Shield on Depreciation on New Machine	=150,000 X 15% X 35% = 7,875	0.3050	= 7,875 X 0.3050 = 2,401.88
9	Tax Shield on Depreciation on New Machine	=150,000 X 7% X 35% = 3,675	0.0.2630	= 3,675 X 0.2630 = 966.53
1-5	Tax shield on Depreciation of Old Machine	= 9,000 X 35% = 3,150	3.2743	=3.2743 X 3,150 = 10,314.05
	NPV			-33,370.64

As NPV of the project is negative i.e $ - 33,370.64 , there it is advisable to not replace the old machine