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 $650,000 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 $265,000. The old machine is being depreciated by $130,000 per year, using the straight-line method. The new machine has a purchase price of $1,175,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $160,000. 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 $240,000 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 expense if the replacement is made. Round your answers to the nearest dollar. Year Depreciation Depreciation Change in Allowance, New Allowance, Old Depreciation 1 $ c. 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

Answer 1

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e 1. * 9W ? vu 07:41 ENG 21-03-207022 10 P iQ IR IS IT JU _A 130000 650000 265000 385000 134750 35% tax IR347 x fe IKILIM IN 334 BIGBEE 335 note depreciation per year on old machine 336 book value = 337 sale price = 338 Loss on sale = 339 tax saving on loss on sale = 340 341 cost of new machine 342 less sale value of old machine 343 less tax saving on sale of old machine 344 add working capital 345 346 347 a intial cash flow at year 0 348 349 b year depreciation cost = 1175000 350 rates depreciation ($) 1175000 265000 134750 775250 -775250 old machine depreciation 351 352 353 354 355 356 357 20.00% 32.00% 19.00% 12.00% 11.00% 235000 376000 223250 141000 129250 change in depreciation A-B 130000 105000 130000 246000 130000 93250 130000 11000 130000 -750 RATIO PIPBP ARR invest, EAA REPLACEMENTS IRRnpvbeta HPR GMAM EAC MACRS RELEVANT Mi-np-ir NPV BETA LEVERED REPLACEMENT BONC... IL

1 2 e . * 9 w x ? LO * 07:43 ENG 21-03-202022 15363 JU _ 24000 365 366 367 368 369 IKILIMIN 10 L IP IQ IR IS IT 359 TOTAL INCREASE IN EARNINGS = 240000 360 incremental net cash flows 361 year EARNINGS(1-t) + change in depreciation*(t) 362 1 240000*(1-0.35) + 105000*(0.35) 192750 363 2 240000*(1-0.35) + 246000*0.35) 242100 364 3 240000*(1-0.35) + 93250*(0.35) 188638 4 240000*(1-0.35) + 11000*(0.35) 159850 5 240000*(1-0.35) -750*(0.35) + after tax salvage 284413 (see note] calcualtion of NPV year cash flow (A) pv factor @ 12% (B) pv of cfat (A*B) NOTE 370 0 -775250 -775250 BOOK VALUE OF NEW MACHINE 70500 1 192750.00 0.8929 172098.21 1175000 X 6% 242100.00 0.7972 193000.64 SALVAGE VALUE 160000 3 188637.50 0.7118 134268.45 PROFIT ON SALE 89500 374 4 159850.00 0.6355 101587.56 TAX ON PROFIT ON SALE 35% 31325 375 5 284412.50 0.5674 161383.29 AFTER TAX SALVAGE VALUE 128675 376 NPV -12912 (160000 - 31325] 377 378 d AS NPV IS NEGATIVE, REPLACEMENT SHOULD NOT BE DONE 379 NEW MACHINE SHOULD NOT BE PURCHASED 380 e 381 1 IF THE EXPECTED LIFE DECREASES, THEN LESS CASHFLOWS WILL BE AVAILABLE AND SO NPV WILL DECREASE 382 2 IF WACC INCREASES, THEN ALSO NPV WILL DECREASE RATIO PI PBP ARR invest, EAA REPLACEMENTS IRRnpvbeta HPR GMAM EAC MACRS RELEVANT Mi-np-ir NPV BETA LEVERED REPLACEMENT BONC ...