Question

Macon Company is considering a new assembly line to replace the existing assembly line. The existing assembly line was installed 2 years ago at a cost of $90,000; it was being depreciated under the straight-line method. The existing assembly line is expected to have a usable life of 4 more years. The new assembly line costs $120,000; requires $8,000 in installation costs and $5,000 in training fees; it has a 4-year usable life and would be depreciated under the straight-line method. The new assembly line will increase output and thereby raises sales by $10,000 per year and will reduce production expenses by $5,000 per year. The existing assembly line can currently be sold for $15,000. To support the increased business resulting from installation of the new assembly line, accounts payable would increase by $5,000 and accounts receivable by $12,000. At the end of 4 years, the existing assembly line is expected to have a market value of $4,000; the new assembly line would be sold to net $15,000 before taxes. Finally, to install the new assembly line, the firm would have to borrow $80,000 at 10% interest from its local bank, resulting in additional interest payments of $8,000 per year. The firm pays 21% taxes and its shareholders require 10% return.

(A) What is the initial cash outlay for this replacement project?

(B) What is the operating cash flow of the project?

(C) What is the terminal cash flow of th

(D) Should you replace the existing assembly line? Provide all

Answer 1

a)	Initial Replacement Cost
	Realisation value of Existing assembly	$15,000
	Cost after depreciation of 2 years	$6,000
	Net Proceeds	$9,000
	Cost of New Assembly
	Cost	$120,000
	Installation	$8,000
	Training	$5,000
		$133,000
	Net Replacement Cost	$124,000

b)	Operating Cash Flows
	Increase in Sale	$10,000
	Decrease in Expenses	$5,000
		$15,000
	Less: Borrowing Cost	$8,000
		$7,000
	Less : Tax Expense	$1,470
		$5,530
	Add: tax benefit of Depreciation	6982.5
	Dep = (133000/4)
	33250*21%
	Net Operating Cash Flows Per year	$12,513

c ) Terminal Cash Flows Will increase by $15010 along with operating Cash Flow.

Sale proceeds of old assembly : $ 4000

Sale proceeds of New Assembly : $ 15000

Net benefit from proceeds post tax : ($4000+$15000)*79%=15010.

d) As Present value of Cash Flows from new Assembly is less than the Initial replacement cost of the assembly, we would not recommend the new assembly.

Year	PV Factor	Yearly Operating Cash Flow	Terminal Cash Flow	Present Value of Cashflows
1	0.909091	$12,513		$11,375.45
2	0.826446	$12,513		$10,341.32
3	0.751315	$12,513		$9,401.20
4	0.683013	$12,513	$15,010	$18,798.58
			TOTAL	$49,916.56