G21
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Question 1
DeYoung Entertainment enterprises is considering replacing the latex molding machine it uses to
fabricate rubber chickens with a newer more efficient model. The old machine is fully depreciated,
obsolete, and has no salvage value. However, even though tis obsolete, it is perfectly functional as
originally designed and can be used for quite a while longer.
The new machine has a purchase price of $ 542,500, an estimated useful life and MACRS class life of 5
years, and an estimated salvage value of $73,500. The applicable depreciation rates are 20%, 32%,
19.20%, 11.52%, 11.52% and 5.76%. Being highly efficient, it is expected to economize on electric
power usage, labor, and repair costs, and, most importantly, to reduce the number of defective chickens.
In total, an annual savings of $87,500 will be realized if the new machine is installed. At the same time,
the use of the new machine would require an increase in net working capital of $14,000 at the very
beginning. The company's marginal tax rate is 35%, and it has a 12% WACC.
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Replacement project
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Year
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Depreciation rates
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Equipment purchases
8
Investment in WC
9
Depreciation
10
NOPAT
11
WC recovered
12
After tax SV
13
Opportunity cost
14
After-tax externalities
15
Net cash flows
16
Cost savings (i.e. Incremental Rev.)
17
NPV
18
Accept the project?(Y/N)
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