Question

REPLACEMENT ANALYSIS The Bigbee Bottling Company is contemplating the replacement of one of its bottling machines with a newer and more efficient one. The old machine has a book value of $600,000 and a remaining useful life of 5 years. The firm does not expect to realize any return from scrapping the old machine in 5 years, but it can s it now to another form in the industry for $280,000. The old machine is being depreciated by $120,000 per year, using the straight-line method The new machine has a purchase price of $1,125,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $125,000. The applicable depreciation rates are 20%, 329,19%, 12%, 11%, and 6%. It is expected to economize on electric power usage, labor, and repair costs, as well as to reduce the number of defective bottles. In total, an annual savings of $230,000 will be realized if the new machine is installed. The company's marginal tax rate is 35%, and it has a 12% WACC a. What initial cash outlay is required for the new machine? Round your answer to the nearest dollar. Negative amount should be indicated by a minus sign b. Calculate the annual depreciation allowances for both machines and compute the change in the annual depreciation experise if the replacement is made. Round your answers to the nearest dollar Year Depreciation Depreciation Change in Allowance, New Allowance, Old Depreciation c. What are the incremental net cash flows in Years 1 through 57 Round your answers to the nearest dollar Year 1 Year 2 Year) Year 4 Years d. Should the um purchase the new machine?

Answer 1

d) No, new machine should not be bought because the total post tax incremental cash inflow at $ 484827 falls short of the initial cash outflow of $845000 required to replace the machine.

e) 1. Decrease in the expected life of the existing machine negatively affects the investment decision as it decreases the annual incremental cash flow generated from the new machine.

2. Increase in WACC negatively affects the investment decision as it decreases the present value of the annual incremental cash flow generated from the new machine over the years.

Note: The solution to the previous parts is in images.
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