Question

7. Problem 12.16 Click here to read the eBook: Replacement Analysis 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 $550,000 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 $110,000 per year, using the straight-line method. The new machine has a purchase price of $1,200,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $145,000. 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 $250,000 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

Answer 1

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projects (Autosaved) (Autosaved) (Autosaved) - Microsoft Excel (Product Activation Failed) Review File Home Insert Page Layout Formulas Data View Add-Ins E AutoSum - Cut A A EWrap Text Calibri 11 General ECopy Fill Merge & Center Insert Delete Format Paste B I U A +.0 .00 Conditional Format Cell Sort & Find & % .00 0 Format Painter Clear Filter Select Formatting as Table Styles Clipboard Editing Font Alignment Number Styles Cells fox GE1412 FZ FX GB GC GE GF GG FV FW FY GA GD GH GI 1412 1413 1414 BIGBEE 1415 depreciation per year on old machine 110000 note 1416 book value = 550000 1417 sale price 265000 1418 Loss on sale= 285000 35% tax 1419 tax saving on loss on sale 99750 1420 1421 cost of new machine 1200000 1422 less sale value of old machine 265000 1423 less tax saving on sale of old machine 99750 add working capital 1424 1425 835250 1426 intial cash flow at year 0 1427 -835250 1428 cost 1200000 change in b depreciation old machine 1429 year depreciation ($) depreciation depreciation 1430 rates 1431 A В A-B 20.00% 110000 1432 4 Rea 1 240000 130000 IRRnpvbeta STO EEE 120% RELEVANT REPLACEMENT BOND invest, EAA MI-np-ir NPV RATION PBP ARR REPLACEMENT S HPR GMAM EAC MACRS BETA LEVERED OPTION TO WAIT II erences WA X 11:23 1ENG 30-10-2019

projects (Autosaved) (Autosaved) (Autosaved) - Microsoft Excel (Product Activation Failed) Review File Home Insert Page Layout Formulas Data View Add-Ins Σ AutoSum - Cut AC Wrap Text Calibri 11 General Copy Fill Conditional Format Formatting as Table Styles Merge & Center Paste B I U +.0 .00 Cell Insert Delete Format Sort & Find & % .00 0 Format Painter Clear Filter Select Clipboard Number Editing Font Alignment Styles Cells f&x GE1447 FX FY GB GC GG FV FW FZ GA GD GE GF GH GI 1428 old machine 1429 b depreciation change in cost 1200000 year 1430 depreciation ($) depreciation depreciation rates 1431 A В A-B 1432 20.00% 1 240000 110000 130000 1433 2 32.00% 384000 110000 274000 19.00% 1434 3 228000 110000 118000 1435 12.00% 34000 4 144000 110000 1436 11.00% 110000 5 132000 22000 1437 1438 1439 TOTAL INCREASE IN EARNINGS = 250000 C 1440 incremental net cash flows EARNINGS(1-t)+ change in depreciation* (t) 1 250000* (1-0.35) 130000*(0.35) 1441 year 1442 208000 2 250000* (1-0.35) 274000* (0.35) 1443 258400 3 250000* (1-0.35) 118000*(0.35) 4 250000* (1-0.35) 34000* (0.35) 5 250000* (1-0.35)+ 22000*(0.35) + AFTER TAX SALVAGE 1444 203800 1445 174400 289650 [SEE NOTE FOR AFTER TAX SALVAGE] 1446 1447 1448 NOTE AFTER TAX SALVAGE VALUE OF NEW MACHINE IRRnpvbeta REPLACEMENT S STO NPV REPLACEMENT BOND invest,EAA MI-np-ir RATION PBP ARR HPR GMAM EAC MACRS RELEVANT BETA LEVERED OPTION TO WAIT II 120% Rea erences WA X 11:24 1ENG 30-10-2019

projects (Autosaved) (Autosaved) (Autosaved) - Microsoft Excel (Product Activation Failed) Review File Home Insert Page Layout Formulas Data View Add-Ins Σ AutoSum - Cut A A Wrap Text Calibri 11 General Copy Fill Merge & Center Conditional Format Formatting as Table Styles Paste в IU* +.0 .00 Cell Insert Delete Format Sort & Find & % .00 0 Format Painter Clear Filter Select Clipboard Alignment Number Styles Editing Font Cells fr GE1460 FZ FW FX GG EV EY GA GB GC GD GE GF GH GI NOTE 1448 AFTER TAX SALVAGE VALUE OF NEW MACHINE 72000 [1200000 X 6%] 1449 BOOK VALUE OF MACHINE 1450 SALVAGE VALUE OF MACHINE 145000 A 1451 PROFIT ON SALE OF MACHINE 73000 1452 25550 B TAX ON PROFIT ON SALE 1453 AFTER TAX SALAVGE VALUE 119450 A-B 1454 d calcualtion of NPV 1455 1456 cash flow pv factor @ 12% pv of cfat year 1457 -835250 -835250 0 1 1458 1 208000.00 0.8929 185714.29 1459 2 258400.00 0.7972 205994.90 1460 3 203800.00 0.7118 145060.81 174400.00 1461 4 0.6355 110834.35 1462 5 289650.00 0.5674 164355.19 1463 1464 NPV -23290.46 1465 NO AS NPV IS NEGATIVE 1466 1467 1 IF THE EXPECTED LIFE DECREASES, THEN LESS CASHFLOWS WILL BE AVAILABLE AND SO NPV WILL DECREASE е 1468 2 IF WACC INCREASES, THEN ALSO NPV WILL DECREASE REPLACEMENTS IRRnpvbeta MI-np-ir BETA LEVERED STO EEE 120% RATION PBP ARRinvest, EAA HPR GMAM EAC MACRS NPV REPLACEMENT BOND RELEVANT OPTION TO WAIT Rea II erences W X 11:24 1ENG 30-10-2019