Question

The Bigbee Bottling Company is contemplating Project A which is a replacement of one of its bottling machines with a newer and more efficient one. At present, the old machine has a book value of $400,000 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 $500,000. The old machine is being depreciated toward a zero salvage value, or by $80,000 per year, using the straight-line method.

                   The new machine has a purchase price of $1,000,000, an estimated useful life and MACRS class life of 5 years and will be depreciated accordingly, if purchased. The company will incur an additional cost of $100,000 for transportation and installation of the new machine. The applicable depreciation rates are 20%, 32%, 19.2%, 11.52%, 11.52%, and 5.76% for years 1 through 6 respectively. The equipment will be sold at an expected price of $50,000 at the end of fifth year. 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 (before-tax) of $240,000 per year for 5 years will be realized if the new machine is installed. The new machine will require an incremental investment of $30,000 in net working capital. The company's marginal tax rate is 21 percent and it has a 15 % cost of capital.

• What is the incremental cash flow (∆CF₀) at t=0 if project A is undertaken?
• What is the incremental cash flow (∆CF1) at t=1 if project A is undertaken?
• What is the incremental operating cash flow (∆OCF5) at t=5 if project A is undertaken?
• What is the incremental non-operating cash flow (∆NOCF5) at t=5 if project A is undertaken?
• What is the NPV of incremental cash flows (incremental cash flows from Year 0 through Year 5)?

Answer 1