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 $600,000 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 $265,000. The old machine is being depreciated by $120,000 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 $255,000 will be realized if the new machine is installed. The company's marginal tax rate is 35% and the project cost of capital is 14%.

1. 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.
   $
2. 
   
3. 
   
4. 
   
5. 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	$	$	$

6. 
   
7. 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	$

8. 
   
9. Should the firm purchase the new machine?
   -Select-Yes No
   
   Support your answer. Do not round intermediate calculations. Round your answer to the nearest dollar.
   
   NPV: $

Answer 1

Answer-a Calculation of initial net cashflow:

Inflow of sale proceeds of old machine $265000

Less: Outflow of purchase price of new machine $(1185000)

Net cash outflow $ 920000

Answer-e

Year Depreciation, New Depreciation, Old Change

1 237000 120000 117000

2 303360    120000 183360

3 123771 120000 3771

4 60004 120000    (59996)

5 26546 120000 (93454)

Calculation of depreciation:

Year Rate Depreciation Balance

1 20% 237000 948000

2 32% 303360 644640

3 19.2% 123771 520869

4 11.52% 60004 460865

5 5.76% 26546 434319

Answer-g

Particulars     CF1 CF2 CF3 CF4 CF5

Annual savings     255000 255000 255000 255000 255000 Less: Depreciation (117000)(183360) (3771) 59996 93454

Profit before tax 138000 71640   251229  314996 348454

Less: Tax @35%    48300 25074 87930 110249 121959

Profit after tax 89700 46566 163299 204747 226495

Add: Depreciation 117000 183360    3771 (59996) (93454)

Cashflow after tax 206700 229926   167070 144751 133041

Answer-i terminal cashflow:

Salvage value 105000

Less:WDV   (434319)

Loss on sale (329319)

Tax saved: 329319 × 35% = 115262

Year Cash Flows DF@14% DCF

0 (920000) 1 (962000)

1 206700 0.877 181276

2 229926 0.769 176813

3 167070 0.675 112772

4 144751 0.592 85693

5 133041 0.519 69048

5 115262 0.519 59821

NPV (234577)

Since buying new machine results in a negative NPV, it is not a feasible option.