Integrative—Determining relevant cash flows Atlantic Drydock is considering replacing an e...

Integrative—Determining relevant cash flows Atlantic Drydock is considering replacing an existing hoist with one of two newer, more efficient pieces of equipment. The existing hoist is 3 years old, cost $32,000, and is being depreciated under MACRS using a 5-year recovery period. Although the existing hoist has only 3 years (years 4, 5, and 6) of depreciation remaining under MACRS, it has a remaining usable life of 5 years. Hoist A, one of the two possible replacement hoists, costs $40,000 to purchase and $8,000 to install. It has a 5-year usable life and will be depreciated under MACRS using a 5-year recovery period. Hoist B costs $54,000 to purchase and $6,000 to install. It also has a 5-year usable life and will be depreciated under MACRS using a 5-year recovery period.

Increased investments in net working capital will accompany the decision to acquire hoist A or hoist B. Purchase of hoist A would result in a $4,000 increase in net working capital; hoist B would result in a $6,000 increase in net working capital. The projected earnings before depreciation, interest, and taxes with each alternative hoist and the existing hoist are given in the following table.

The existing hoist can currently be sold for $18,000 and will not incur any removal or cleanup costs. At the end of 5 years, the existing hoist can be sold to net $1,000 before taxes. Hoists A and B can be sold to net $12,000 and $20,000 before taxes, respectively, at the end of the 5-year period. The firm is subject to a 40% tax rate. (Table 4.2 contains the applicable MACRS depreciation percentages.)

a. Calculate the initial investment associated with each alternative.

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b. Calculate the incremental operating cash inflows associated with each alternative. (Note: Be sure to consider the depreciation in year 6.)

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c. Calculate the terminal cash flow at the end of year 5 associated with each alternative.

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d. Depict on a time line the relevant cash flows associated with each alternative.

TABLE 4.2 Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes