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 $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 $260,000. 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 $1,180,000, 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 15%.

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?
10. Support your answer. Do not round intermediate calculations. Round your answer to the nearest dollar.
    
    NPV: $

Answer 1

Answer : Calculation of Initial Net Cash Flow

Initial Cash Flow = Purchase Price of New Machine - Sale Value of Old Machine - Tax on Sale of Old Machine

Tax on Sale of Old Machine = (Book Value - Sale Value) * Tax Rate

= (800,000 - 260000) * 35%

= 189000

Initial Cash Flow = Purchase Price of New Machine - Sale Value of Old Machine - Tax on Sale of Old Machine

= 1,180,000 - 260,000 - 189,000

= -731000

(b.) Calculation of Change in Depreciation

Year	Depreciation New (Initial Cost * MACRS Rate)	Depreciation on Old	Change in Depreciation
1	236000	160000	76000
2	377600	160000	217600
3	226560	160000	66560
4	135936	160000	-24064
5	135936	160000	-24064

(c.) Calculation of Incremental Cash Flows :

Below is the Table showing Incremental Cash Flows :

Year	After Tax Cash Flow [Annual saving * (1 - Tax Rate)]	Change in Depreciation * Tax Rate	Incremental Cash Flows
1	165750	26600	192350
2	165750	76160	241910
3	165750	23296	189046
4	165750	-8422.4	157327.6
5	165750	-8422.4	157327.6 + After Tax Salvage Value i.e 92038.80 = 249366.4

After Tax Salvage Value = Salvage Value - Tax on Gain on Sale

Tax on Gain Sale of Old Machine = ( Sale Value - Book Value ) * Tax Rate

= [ 105000 - (1180000*5.76%) ] * 35%

= 12961.2

After Tax Salvage Value = 105000 - 12961.2

= 92038.8

(d.) Below is the table showing Net Present value :

Year	Cash Inflow	Present Value Factor @15%	Present value of cash inflow
1	192350	0.869565217	167260.8696
2	241910	0.756143667	182918.7146
3	189046	0.657516232	124300.8137
4	157327.6	0.571753246	89952.56592
5	249366.4	0.497176735	123979.1726
		Total Present value of cash inflow	688412.1364
		Less : Cash outflow	731000
		Net Present Value	-42587.86

No not to purchase as Net Present Value is negative.