BU393 Lecture Notes - Lecture 5: Cash Flow, Net Present Value
10.3
Replacement Projects:
- To evaluate a replacement, we compare two scenarios:
1. Keeping old equipment
2. Replacing it
- Calculate cash flows with replacement and subtract cash flows that would have been
received with the old. The differences are the incremental cash flows from replacement
- To assess a replacement decision, we estimate the net present value of the incremental
cash flows – if NPV is positive, we replace
- At time 0, incremental cash flows are proceeds from selling old assets minus cost of
buying new
- In terminal year, we must get salvage value of new asset less the foregone salvage value
of the old asset
- When an asset is replaced, the CCA system adds the cost of the new machine to the
asset class and deducts the salvage value of the old machine – always increases the UCC
balance in that class. THERE ARE NO TAX IMPLICATIONS WITH PURCHASE OF THE NEW
ASSET OR THE SALE OF THE OLD ASSET
Operating Cash Flows:
- Incremental annual operating cash flows for a replacement are the difference between
the operating cash flows after replacement and the operating cash flows with old asset
- Difference between new depreciation expense and the old one is incremental
depreciation – amount that depreciation changes because of the purchase of the new
machine
- Change to the UCC of the class is the incremental capital cost, which is the cost of the
new machine minus the salvage value of the old machine. So the incremental
depreciation expense is the declining balance depreciation expense from the
incremental capital cost
Terminal Cash Flows:
- When the project ends the cash invested in the working capital is no longer needed and
is returned – so a decrease in net working capital is a positive cash flow in the terminal
year
Net Incremental Salvage:
- Difference between the salvage value of the new machine and the salvage value of the
old machine had it been kept in service = incremental salvage + PV of the tax shields –
tax shields foregone because the company did not sell old asset
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
To evaluate a replacement, we compare two scenarios: keeping old equipment, replacing it. Calculate cash flows with replacement and subtract cash flows that would have been received with the old. The differences are the incremental cash flows from replacement. To assess a replacement decision, we estimate the net present value of the incremental cash flows if npv is positive, we replace. At time 0, incremental cash flows are proceeds from selling old assets minus cost of buying new. In terminal year, we must get salvage value of new asset less the foregone salvage value of the old asset. When an asset is replaced, the cca system adds the cost of the new machine to the asset class and deducts the salvage value of the old machine always increases the ucc balance in that class. There are no tax implications with purchase of the new. Asset or the sale of the old asset.
