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At times firms will need to decide if they want to continue to use their current equipment or to replace the equipment with newer equipment. The company will need to do a replacement analysis to determine which option is the best financial decision for the company.
Price Co. is considering replacing an existing piece of equipment. The project involves the following:
– The new equipment will have a cost of $1,200,000, and it will be depreciated on a straight e basis over a period of six years (years 1-6)
– The old machine is also 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 an investment in net working capital (NWC) of $20,000 that will be recovered at the end of the project’s life.
– Replacing the old machine will require The new machine is more efficient, so the firm’s incremental earnings before interest and taxes (EBIT) will increase by a total of $600,000 in each of the next six years.
– The project’s cost of capital is 13%.
– The company’s annual tax rate is 40%.
Compute the incremental cash flows associated with the replacement of the old equipment with the new equipment