How to calculate the npv of the replacement decision

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Reference no: EM132659049

Last year Justice League Services purchased and installed a new X1600 Wall-E Super-Smasher used in compacting cars, SUVs, and small trucks into 2 cubic yards of compacted metal. The X-1600 Wall-E cost $688,000 and had a "useful life" of 6 years. Recently the firm's CEO became aware of a new technology that promised many advantages over the X-1600 Wall-E, including compacting the junk vehicles into 1 cubic yard of compacted metal instead of 2 cubic yards. He asked his CPA to do a financial analysis to determine if a new Super-Smasher called the EVE-1000 could be an economically viable replacement for a Super-Smasher (the X-1600) that was only one year old. The CPA determined that the new technology could be purchased for $900,000 today and would have a useful life of 5 years before it would likely become technologically obsolete and be essentially worthless (the EVE-1000 runs hotter than the X-1600 Wall-E and has a shorter useful life). For depreciation purposes the company uses the straight line method.

Aquaman, the Justice League VP of Scrap Yard Services and the firm's CPA agreed that the new machine could significantly improve production and create higher revenues for the firm. With this information the CPA estimated that the new technology will produce EBITDA (earnings before interest, taxes, depreciation and amortization) of $480,000 per year for the next 5 years.

Problem 1: The current machine is expected to produce EBITDA of $365,000 per year. The current machine is being depreciated on a straight line basis over a useful life of 6 years after which it will have a $28,000 salvage value. All other expenses of the two machines are identical. The market value of the current machine is $525,000. Your company's tax rate is 21% and the cost of capital is 14%. Calculate the NPV of the replacement decision and choose the best answer below. NOTE: DO NOT make any assumptions regarding the tax treatment for the gain or loss on the disposal the X-1600 Wall-E.

[A] Do not buy the EVE-1000, reduces profits by $5,484

[B] Do not buy the EVE-1000, reduces profits by $12,638

[C] Buy the EVE-1000, increases profits by $5,484

[D] Buy the EVE-1000, increases profits by $25,118

[E] Buy the EVE-1000, increases profits by $98,274

[F] Do not buy the EVE-1000, reduces profits by $252,954

Reference no: EM132659049

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