Question

De Young Entertainment Enterprises is considering replacing the latex molding machine it uses to fabricate rubber chickens with a newer, more efficient model. The old machine has a book value of $600,000 and a remaining useful life of 5 years. The current machine would be worn out and worthless in 5 years, but De Young can sell it now to a Halloween mask manufacturer for $180,000. The old machine is being depreciated by $120,000 per year for each year of its remaining life. If De Young doesn't replace the old machine, it will have no salvage value at the end of its useful life. The new machine has a purchase price of $725,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $105,000. The applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. Being highly efficient, it is expected to economize on electric power usage, labor, and repair costs, and, most importantly, to reduce the number of defective chickens. In total, an annual savings of $175,000 will be realized if the new machine is installed. The company's marginal tax rate is 25% and the project cost of capital is 14%. a. What is the initial net cash flow if the new machine is purchased and the old one is replaced? Round your answer to the nearest dollar. Cash outflow, if any, should be indicated by a minus sign. b. What is the incremental depreciation tax shield (i.e., the change taxes due to the change in depreciation expenses) if the replacement is made? (Hint: First calculate the annual depreciation expense for the new machine and compare it to the depreciation on the old machine.) Do not round intermediate calculations. Round your answers to the nearest dollar. Negative values, if any, should be indicated by a minus sign. Incremental depreciation tax shield Year A A A A A c. What is the after-tax salvage value at Year 5? Do not round intermediate calculations. Round your answer to the nearest dollar. Negative value, if any, should be indicated by a minus sign. d. What are the total incremental project cash flows in Years 0 through 5? What is the NPV? Do not round intermediate calculations. Round your answers to the nearest dollar. Negative values, if any, should be indicated by a minus sign.

Answer 1

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- 2x projects (Autosaved) (Autosaved) (Autosaved) - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins % Cut Calibri 11 AA = = = pt Wrap Text General Ea Copy Paste B I U Format Painter - D A Merge & Center $ - % Conditional Format 8. Cell Insert Delete Format Formatting as Table Styles Clipboard Font Alignment Number Styles Cells JQ410 - fix year 2 IN JO P Q JR JS JU JV Σ AutoSum : A Fill Sort & 2 Clear Filter Editing Find & Select W X JY 392 DEYOUNG note 393 394 395 396 397 398 399 400 401 402 403 404 405 406 depreciation per year on old machine book value sale price = loss on sale = tax on loss = tax credit 120000 600000 180000 420000 105000 CALCULATION OF CASH OUTFLOW cost of new machine less sale value of old machine less tax on sale of old machine 725000 180000 105000 440000 407 a intial cash flow at year o -440000 408 409 410 N Rea note RATION PBP ARR year invest, EAA depreciation cost = 725000 MI-np-ir_ REPLACEMENT S HPR GMAM old machine change in EAC MACRS NPV RELEVANT BETA LEVERED I REPLACEMENT BOND IRRnpvbeta ferences OPTION TO WAIT BOU 130% STEIN id < > 0 ENG 02:24 21-11-2019 • E 9 . *

projects (Autosaved) (Autosaved) (Autosaved) - Microsoft Excel (Product Activation Failed) Data Review View Add-Ins File Home Insert Page Layout Formulas - 2x % Cut 11 A = = = V General A A Wrap Text Merge & Center U - D $ - % 8. Conditional Format Formatting as Table Styles Cell Styles Insert Delete Format Σ AutoSum : A Fill Sort & 2 Clear Filter Editing Find & Select Font Alignment Number Cells fix Calibri E Copy Paste Format Painter B I Clipboard JP425 - L IN JO 409 410 411 412 P JQ R JU JV W X Y = note year depreciation rates cost = 725000 depreciation ($) old machine depreciation B change in depreciation A-B 413 1 20.00% 32.00% 19.20% 11.52% 11.52% 145000 232000 139200 83520 83520 120000 120000 120000 120000 120000 25000 112000 19200 -36480 -36480 414 415 416 417 418 419 420 421 BOOK VALUE OF NEW MACHINE SALE VALUE OF NEW MACHINE PROFIT ON SALE TAX ON PROFIT ON SALE AFTER TAX SALVAGE 41760 [725000 X 5.76%] 105000 63240 15810 89190 422 423 424 425 426 427 H RATION PBP ARR invest, EAA MI-np-ir_ REPLACEMENT S HPR GMAM EAC MACRS NPV RELEVANT BETA LEVERED I RRnpvbeta ferences Rea REPLACEMENT BOND OPTION TO WAITSTEIN II < 0 BOU 130% 0 • E 9 . * ENG 02:24 21-11-2019

projects (Autosaved) (Autosaved) (Autosaved) - Microsoft Excel (Product Activation Failed) Data Review View Add-Ins Formulas - 2x 11 A = = = V General A A Wrap Text Merge & Center m Find & 8. File Home Insert Page Layout % Cut Calibri Ea Copy Paste Format Painter B I U - D Clipboard Font JP446 Fax L IN JO JP Insert Delete Format $ - % Number Conditional Format Formatting as Table Styles Cell Styles Σ AutoSum : A Fill 2 Sort & 2 Clear Filter Editing Select Alignment Cells JR JS JU V W X JY 429 430 431 432 433 434 435 436 437 438 J Q incremental net cash flows year savings(1-t) + change in depreciation*(t) 1 175000*(1-0.25) + 25000*(0.25) 2 175000*(1-0.25) + 112000*(0.25) 3 175000*(1-0.25) + 19200*(0.25) 4 175000*(1-0.25) -36480*(0.25) 5 175000*(1-0.25) + 36480*(0.25) + after tax salvage 137500 159250 136050 122130 211320 year 439 1 NOTE cash flow pv factor @ 14% pv of cfat -440000 137500 0.8772 159250 0.7695 136050 0.6750 122130 0.5921 211320 0.5194 -440000 120614 122538 91830 72311 109753 5 440 441 442 443 444 445 446 447 NPV 77045 AS NPV IS POSITIVE, REPLACEMENT SHOULD BE DONE R N invest, EAA MI-np-ir REPLACEMENT S HPR GMAM EAC MACRS NPV RELEVANT BETA LEVERED REPLACEMENT BOND O IRRnpvbetaRATION PBP ARR ferences OPTION TO WAITSTEIN IDI BOU 130% 0 Rea 1a e 9 5 W • E 9 . * ENG 02:25 21-11-2019