Question

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%.

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.
$

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	$	$	$

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	$

Should the firm purchase the new machine?

NPV: $

Answer 1

Book value of old machine		800000
proceeds from sale of old machine		270000
loss on sale of old machine		530000
tax benefit on loss on sale of old machine	530000*35%	185500
net proceeds with tax benefits	270000+185500	455500
1-
Initial net cash flow
cost of new machine		1185000
less net proceeds with tax benefits of old machine		455500
Initial net cash flow		729500
Year	cost of new machine	MACRS rate	Annual Depreciation	Annual depreciation on old machine	incremental depreciation
1	1185000	20%	237000	160000	77000
2	1185000	32%	379200	160000	219200
3	1185000	19.20%	227520	160000	67520
4	1185000	11.52%	136512	160000	-23488
5	1185000	11.52%	136512	160000	-23488
Year	0	1	2	3	4	5
Initial net cash flow	-729500
annual saving		245000	245000	245000	245000	245000
less incremental depreciation		77000	219200	67520	-23488	-23488
after depreciation saving		168000	25800	177480	268488	268488
after tax savings = after depreciation savings*(1-.35)		109200	16770	115362	174517.2	174517.2
annual operating saving = after tax savings+incremental depreciation		186200	235970	182882	151029.2	151029.2
tax benefit on disposal of new machine	0	0	0	0		23889.6
net annual operating savings	-729500	186200	235970	182882	151029.2	174918.8
present value of cash flow = cash flow/(1+r)^n r=15%	-729500	161913.0435	178427.2	120247.9	86351.44	75088.2
NPV = sum of present value of net operating savings	-107472.21
npv is negative so machine should not be purchased
BOOK value of new machine at the end of year 5	1185000*5.76%	68256
tax benefit on disposal of new machine	68256*.35	23889.6