Computation of NPV using Incremental Cash Flows
Kaufman Chemical is evaluating the purchase of a new multi-stage centrifugal compressor for its wastewater treatment operation which costs $750,000 and requires $57,000 to install. This outlay would be partially offset by the sale of an existing compressor originally purchased five years ago for $490,000. It is being depreciated using a five-year recovery schedule under ACRS and can currently be sold for $150,000. The existing compressor's maintenance costs are increasing, and the new compressor could reduce operating costs before depreciation and taxes by $280,000 annually for the next five years. The new equipment will be depreciated under a five-year recovery schedule using ACRS (schedule below). The firm has an 18% cost of capital and a 40% tax of ordinary and capital gain income.
Evaluate whether Kaufman Chemical should replace its existing wastewater treatment equipment with the new compressor. (Do not consider the terminal value of the new compressor in your analysis.)
|
Year
|
Depreciation of
Existing Equipment
|
Depreciation
of New Equipment
|
Incremental
Depreciation
|
|
1
|
0.05 ´ $490,000 = $24,500
|
0.20 ´ $807,000
|
=
|
$161,400
|
$136,900
|
|
2
|
0
|
0.32 ´ $807,000
|
=
|
258,240
|
258,240
|
|
3
|
0
|
0.19 ´ $807,000
|
=
|
153,330
|
153,330
|
|
4
|
0
|
0.12 ´ $807,000
|
=
|
96,840
|
96,840
|
|
5
|
0
|
0.12 ´ $807,000
|
=
|
96,840
|
96,840
|
|
6
|
0
|
0.05 ´ $907,000
|
=
|
40,350
|
40,350
|