Question

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 $625,000 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 sell it now to another firm in the industry for $295,000. The old machine is being depreciated by $125,000 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%, 32%, 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.

1. 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.
   $
   
2. Calculate the annual depreciation allowances for both machines and compute the change in the annual depreciation expense if the replacement is made. Round your answers to the nearest dollar.

   Year	Depreciation Allowance, New	Depreciation Allowance, Old	Change in Depreciation
   1	$	$	$
   2
   3
   4
   5

3. What are the incremental net cash flows in Years 1 through 5? Round your answers to the nearest dollar.

   Year 1	Year 2	Year 3	Year 4	Year 5
   $	$	$	$	$

4. Should the firm purchase the new machine?
   -Select-

Answer 1

Question a: Calculation of Initial Investment outlay for Spectrometer Particulars Year 0 New Bottling Machine ($1,125,000) Old Bottling Machine Initial Investment Outlay $295,000 ($830,000) Therefore, Initial cash outlay for bottling machine is ($830,000)

Year Question b: Calculation of Depreciation for New machine Depreciation Depreciaiton Rate Depreciation 1125000 20% 225000 1125000 32% 360000 1125000 19% 213750 1125000 12% 135000 5 1125000 11% 123750 Calculation of annual depreciation allowance for both machines Depreciation Depreciation Allowance Allowance, Chanage in Year New old Depreciation 225000 125000 1 100000 360000 125000 235000 3 213750 125000 88750 135000 125000 10000 5 123750 125000 -1250 2

Question c: Calculation of Incremental Net Salvage Value Particulars Amount New Bottling machine (A) $125,000 Less: Unclaimed Depreciation (B) ($1,125,000 * 6%) Incremental Salvage Value (C = A-B) Less: Tax @35% (D = C*35%) After Tax salvage value (E = C-D) Add back Unclaimed Depeciation (FEB) Net salvage value (G=E+F) 67500 $57,500 $20,125 $37,375 67500 $104,875

Year 1 Year 2 Year 3 Year 4 Year 5 Calculation of Incremental Cash Flows Particulars Operating Cash Flows Annual Savings (A) Less: Incremental Depreciation (B) Profit Before Tax (C = A-B) Less: Tax @35% (D = C*35%) Profit After Tax (E = C-D) Add back Incremental Depreciation (F= B) Net Operating Cash Flows (G = E+F) 230000 100000 130000 45500 84500 100000 184500 230000 230000 235000 88750 -5000 141250 1 -1750 49437.5 -325091812.5 235000 88750 231750 180562.5 230000 10000 220000 77000 143000 10000 153000 230000 -1250 231250 80937.5 150312.5 -1250 149062.5 104875 Terminal value Incremental Salvage Value (H) Total annual cash flows (1 = G+H) 184500 2 31750 180562.5 153000 253937.5

Question d: Calculation of NPV of the project Year Cash Flows Discount Factor @12% Discounted Cash Flows C = 1/(1+12%)^n n=0,1,2,3,4,5 D=B*C 0 -830000 -830000 184500 0.892857143 164732.1429 231750 0.797193878 184749.6811 180562.5 0.711780248 128520.821 153000 0.635518078 97234.266 5 253937.5 0.567426856 144090.9572 NPV of the project -110672.1319

Since NPV of the project is negative, Firm should not purchase the machine