Question

DeYoung Entertainment Enterprises is considering replacing the latex molding machine it uses to fabricate rubber chickens with a newer, more efficient model. The old machine has a book value of $800,000 and a remaining useful life of 5 years. The current machine would be worn out and worthless in 5 years, but DeYoung can sell it now to a Halloween mask manufacturer for $270,000. The old machine is being depreciated by $160,000 per year for each year of its remaining life.

The new machine has a purchase price of $1,185,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $105,000. The applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. Being highly efficient, it is expected to economize on electric power usage, labor, and repair costs, and, most importantly, to reduce the number of defective chickens. In total, an annual savings of $245,000 will be realized if the new machine is installed. The company's marginal tax rate is 35% and the project cost of capital is 15%.

a. What is the initial net cash flow if the new machine is purchased and the old one is replaced? Round your answer to the nearest dollar.


b. Calculate the annual depreciation allowances for both machines, and compute the change in the annual depreciation expense if the replacement is made. Do not round intermediate calculations. Round your answers to the nearest dollar.

Year	Depreciation Allowance, New	Depreciation Allowance, Old	Change in Depreciation
1	$	$	$
2	$	$	$
3	$	$	$
4	$	$	$
5	$	$	$

c. What are the incremental net cash flows in Years 1 through 5? Do not round intermediate calculations. Round your answers to the nearest dollar.

CF1	$
CF2	$
CF3	$
CF4	$
CF5	$

d. What is the NPV?

Answer 1

a) Initial net cash flow = Purchase price of new machine - selling out price of old machine = 1185000 - 270000 = $915000
b) Annual depreciation allowances :
Year	Dep All, New	Dep Allow, Old	Change in Depreciation
1	237000	160000	77000
2	379200	160000	219200
3	227520	160000	67520
4	136512	160000	-23488
5	136512	160000	-23488
c)
Year	saving	dep	Total cost saving	After tax saving (*0.65)	Net cash flow
1	245000	237000	8000	5200	242200
2	245000	379200	-134200	-87230	291970
3	245000	227520	17480	11362	238882
4	245000	136512	108488	70517	207029
5	245000	136512	108488	70517	207029
d) NPV :
Year	Net cash flow	Discount rate 15%	PV
1	242200	0.87	210714
2	291970	0.756	220729
3	238882	0.658	157184
4	207029	0.572	118421
5	207029	0.497	102894
less:Initial cash outflow			-915000
NPV			-105058