Question

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 $280,000. The old machine is being depreciated by $110,000 per year, using the straight-line method.

The new machine has a purchase price of $1,125,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $125,000. 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 $215,000 will be realized if the new machine is installed. The company's marginal tax rate is 35%, and it has a 12% WACC.

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

3. 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
   $	$	$	$	$

Answer 1

Cost Of new machine	1,125,000.00	$
Salvage value	125,000.00	$
Depreciable amount	1,000,000.00	$
Life of project	5	Years
Tax rate	35	%
WACC	12	%
Incremental Earnings before depreciation	215,000.00	$
Old machine can be sold now for	280,000.00	$
Depreciation per year of old machine	110,000.00	$

Initial cash outflow for new machine
Cost Of new machine	(1,125,000.00)	$
Less: Old machine sales	280,000.00	$
Initial cash outflow for new machine	(845,000.00)	$

Year	Depreciation rate	Depreciation
1	20%	200,000.00
2	32%	320,000.00
3	19%	190,000.00
4	12%	120,000.00
5	11%	110,000.00
6	6%	60,000.00
Total		1,000,000.00

a. Year	Depreciation Allowance, New	Depreciation Allowance, Old	Change in Depreciation
1	200,000.00	110,000.00	90,000.00
2	320,000.00	110,000.00	210,000.00
3	190,000.00	110,000.00	80,000.00
4	120,000.00	110,000.00	10,000.00
5	110,000.00	110,000.00	-

Year	PV factor 12% [1/(1+r)]^n
1	0.893
2	0.797
3	0.712
4	0.636
5	0.567

C	Year	1	2	3	4	5
	Incremental Earnings before depreciation	215,000.00	215,000.00	215,000.00	215,000.00	215,000.00
	Less : change in Depreciation	90,000.00	210,000.00	80,000.00	10,000.00	-
	Earnings after depreciation	125,000.00	5,000.00	135,000.00	205,000.00	215,000.00
0.35	Tax 35%	43,750.00	1,750.00	47,250.00	71,750.00	75,250.00
	Earnings after tax	81,250.00	3,250.00	87,750.00	133,250.00	139,750.00
	Add: Depreciation	90,000.00	210,000.00	80,000.00	10,000.00	-
	Cash Inflow	171,250.00	213,250.00	167,750.00	143,250.00	139,750.00
	PV factor 12% [1/(1+r)^n]	0.893	0.797	0.712	0.636	0.567
	Discounted Inflow= Cash inflow * total PV factor	152,901.79	170,001.59	119,401.14	91,037.96	79,297.90	612,640.38
	Total Discounted inflow	Discounted cashflow + discounted salvage value
		612640.38 + (125000*0.567)
		683,568.74	$

D	NPV of the project
	Total Discounted inflow	683,568.74	$
	Less initial outflow	(845,000.00)	$
	NPV of the project	(161,431.26)	$
	Since the NPV is negative, firm should not purchase the new machine