The Gilbert Instrument Corporation is considering replacing

The Gilbert Instrument Corporation is considering replacing the wood steamer it currently uses to shape guitar sides. The steamer has 6 years of remaining life. If kept, the steamer will have depreciation expenses of $350 for 6 years. Its current book value is $2,100, and it can be sold on an Internet auction site for $4,500 at this time. Thus, the annual depreciation expense is $2,100/6=$350 per year. If the old steamer is not replaced, it can be sold for $800 at the end of its useful life.

Gilbert is considering purchasing the Side Steamer 3000, a higher-end steamer, which costs $8,100, and has an estimated useful life of 6 years with an estimated salvage value of $900. This steamer falls into the MACRS 5-years class, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The new steamer is faster and allows for an output expansion, so sales would rise by $2,000 per year; the new machine\'s much greater efficiency would reduce operating expenses by $1,500 per year. To support the greater sales, the new machine would require that inventories increase by $2,900, but accounts payable would simultaneously increase by $700. Gilbert\'s marginal federal-plus-state tax rate is 40%, and the project cost of capital is 15%. Should it replace the old steamer?

What is the NPV of the project? Do not round intermediate calculations. Round your answer to the nearest dollar.
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Solution

Cash outflow at Year 0 Purchase Price -8100 Sale of Old machine 4150 Tax on sale of old machine (4500-2100)*40% -960 Net Working capital (2900-700) -2200 -7110 Annual Cash flows Sales Increase 2000 Cost decrease 1500 Increase in pre-tax revenues 3500 Tax @ 40% 1400 After-tax revenue increase 2100 Calculate the Depreciation Tax Savings 1 2 3 4 5 6 New 1620 2592 1555.2 933.12 933.12 466.56 Old 350 350 350 350 350 350 Change 1270 2242 1205.2 583.12 583.12 116.56 Depreciation tax savings 508 897 482 233 233 47 NPV Calculation 0 1 2 3 4 5 6 Cash outflow -7110 After-tax sales revenue 2100 2100 2100 2100 2100 2100 Depreciation tax savings 508 897 482 233 233 47 Working capital recovery 2200 Salvage Value of new machine 900 Tax on Salvage value -360 Opportunity cost of old machine -480 800*(1-0.60) Project cash flows -7110 2608 2997 2582 2333 2333 4407 Discounting factor @ 15% 1 0.869565 0.756144 0.657516 0.571753 0.497177 0.432328 -7110 2267.826 2266.163 1697.707 1333.9 1159.913 1905.268 Net Present Value 3520.777 Since NPV is positive, replacement must be made