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 $625,000 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 $265,000. The old machine is being depreciated by $125,000 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 $205,000 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
   $	$	$	$	$

please help! Thank you!

Answer 1

a)

Gain /(loss) on sale of old machine =Sale value -book value

                      = 265000 - 625000

                       = - 360000

Tax saving due to loss= -360000* 35%= -126000

After tax cash flow from sale of old machine = sale value - Tax saving

                          = 265000 - (- 126000)

                           = 265000 + 126000

                          = 391000

Purchase cost of new machine	-1125000
After tax cash flow from sale of old machine	391000
Initial outlay	- 734000

b)

Year	Depreciation Allowance, New [A]	Depreciation Allowance, Old [B]	Change in Depreciation[A-B]
1	1125000*32%= 360000	125000	235000
2	1125000*19%= 213750	125000	88750
3	1125000*12%= 135000	125000	10000
4	1125000*11%= 123750	125000	-1250
5	1125000*6%= 67500	125000	-57500
Total	900000	625000

c)

	1	2	3	4	5
Annual saving	205000	205000	205000	205000	205000
less:Incremental depreciation	-235000	-88750	-10000	1250	57500
Income before tax	-30000	116250	195000	206250	262500
less:Tax [Income before tax *35%]	10500	-40687.5	-68250	-72187.5	91875
Net Income	-19500	75562.5	126750	134062.5	170625
Add:depreciation (being non cash)	235000	88750	10000	-1250	-57500
After tax sale value on old machine					160000
Incremental cash flow	215500	164313	136750	132813	273125

Working :

Book value of new machine at end of year 5 =cost -accumulated depreciation

                    = 1125000 -900000

                    = 225000

Loss on sale = 125000 -225000 = -100000

Tax saving due to loss on sale = -100000*35%=-35000

After tax sale value =sale value -tax saving

                 = 125000 - (-35000)

                 = 125000 +35000

                  = 160000