Question

# Price Co. is considering replacing an existing piece of equipment. The project involves the following: •...

Price Co. is considering replacing an existing piece of equipment. The project involves the following:

 • The new equipment will have a cost of \$1,800,000, and it is eligible for 100% bonus depreciation so it will be fully depreciated at t = 0. • The old machine was purchased before the new tax law, so it is being depreciated on a straight-line basis. It has a book value of \$200,000 (at year 0) and four more years of depreciation left (\$50,000 per year). • The new equipment will have a salvage value of \$0 at the end of the project's life (year 6). The old machine has a current salvage value (at year 0) of \$300,000. • Replacing the old machine will require an investment in net operating working capital (NOWC) of \$45,000 that will be recovered at the end of the project's life (year 6). • The new machine is more efficient, so the firm’s incremental earnings before interest and taxes (EBIT) will increase by a total of \$700,000 in each of the next six years (years 1–6). Hint: This value represents the difference between the revenues and operating costs (including depreciation expense) generated using the new equipment and that earned using the old equipment. • The project's cost of capital is 13%. • The company's annual tax rate is 25%.

Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment.

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Initial investment
EBIT
– Taxes
– Δ Depreciation × T
+ Salvage value
– Tax on salvage
– NOWC
+ Recapture of NOWC
Total free cash flow

The net present value (NPV) of this replacement project is:

\$963,147

\$818,675

\$1,107,619

\$722,360

#### Earn Coins

Coins can be redeemed for fabulous gifts.