Question

REPLACEMENT ANALYSIS The Bigbee Bottling Company is contemplating the replacement of one of its bottling machines with newer and more efficient one. The old machine has a book value of $575,000 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 $280,000. The old machine is being depreciated by $115,000 per year, using the straight-line method. The new machine has a purchase price of $1,150,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $120,000. 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 $235,000 will be realized if the new machine i installed. The company's marginal tax rate is 35%, and it has a 12% WACC. a. What initial cash outlay 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 $ 2 3 4 5 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 d. Should the firm purchase the new machine? -Select- Support your answer. The input in the box below will not be graded, but may be reviewed and considered by your instructor. In general, how would each of the following factors affect the investment decision, and how should each be treated? 1. The expected life of the existing machine decreases The input in the box below will not be graded, but may be reviewed and considered by your instructor. 2. The WACC is not constant, but is increasing as Bigbee adds more projects into its capital budget for the year. The input in the box below will not be graded, but may be reviewed and considered by your instructor.

Answer 1

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C w ? ENG 05:32 01-08-2020 66 35 x IK277 X . 10 IQ IR IS IT IU IV IW IK IL IM IN IP 277 278 BIGBEE 279 note depreciation per year on old machine 115000 280 book value = 575000 281 sale price = 280000 282 Loss on sale = 295000 283 tax saving on loss on sale = 35% tax 103250 284 285 cost of new machine 1150000 286 less sale value of old machine 280000 287 less tax saving on sale of old machine 103250 288 add working capital 289 766750 290 291 A intial cash flow at year o -766750 292 293 note year depreciation cost = 1150000 old machine change in 294 rates depreciation ($) depreciation depreciation 295 A B A-B 296 1 20.00% 230000 115000 115000 297 2 32.00% 368000 115000 253000 298 3 19.00% 218500 115000 103500 299 4 12.00% 138000 115000 23000 300 5 11.00% 126500 115000 11500 301 MI-np-ir BETA LEVERED NPV CCA REPLACEMENT BOND OPTION TO WAIT STEIN indiffEPS EBIT OCF 1 LEASE SLM MACRS GOLF I ... +

C w ENG 05:32 01-08-2020 66 35 X IS325 . IK IP IQ IR IS IT IU IV IW 303 b 304 305 306 307 308 IL IM IN IO TOTAL INCREASE IN EARNINGS = 235000 incremental net cash flows year EARNINGS(1-t) + change in depreciation*(t) 1 235000*(1-0.35) + 115000* (0.35) 2 235000*(1-0.35) + 253000*(0.35) 3 235000*(1-0.35) + 103500*(0.35) 4 235000*(1-0.35) + 23000*(0.35) 5 235000*(1-0.35) + 11500*(0.35) + AFTER TAX SALVAGE 193000 241300 188975 309 160800 258925 (SEE NOTE BELOW] 310 311 312 313 calcualtion of NPV year py of cfat NOTE cash flow pv factor @ 12% -766750 314 0 1 -766750 69000 1 193000.00 0.8929 172321.43 192362.88 BOOK VALUE OF NEW MACHINE 1150000 X 6% SALVAGE VALUE 2 241300.00 0.7972 120000 3 188975.00 0.7118 PROFIT ON SALE 51000 315 316 317 318 319 320 C 4 160800.00 0.6355 134508.67 102191.31 146921.00 35% 17850 TAX ON PROFIT ON SALE AFTER TAX SALVAGE VALUE 5 258925.00 0.5674 102150 NPV -18445 321 322 D 323 AS NPV IS NEGATIVE, REPLACEMENT SHOULD NOT BE DONE NEW MACHINE SHOULD NOT BE PURCHASED 324 E 325 1 IF THE EXPECTED LIFE DECREASES, THEN LESS CASHFLOWS WILL BE AVAILABLE AND SO NPV WILL DECREASE 2 IF WACC INCREASES, THEN ALSO NPV WILL DECREASE 326 327 MI-np-ir BETA LEVERED NPV CCA REPLACEMENT BOND OPTION TO WAIT STEIN indiffEPS EBIT OCF 1 LEASE SLM MACRS GOLF I ... +