Question

Replacement Analysis

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 $270,000. 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 12%.

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-YesNoItem 22
   
   Support your answer. Do not round intermediate calculations. Round your answer to the nearest dollar.
   
   NPV: $

Answer 1

Answer a						Answer e
Calculation of initial net cash flow if the new machine is purchased and old one is replaced						Year	Depreciation allowance new	Depreciation allowance old	Change in depreciation
Purchase cost of new machine	-$1,185,000.00					1	$237,000	$120,000	$117,000
Cash inflow from sale of old machine	$387,250.00					2	$379,200	$120,000	$259,200
Initial net cash flow	-$797,750.00					3	$227,520	$120,000	$107,520
						4	$136,512	$120,000	$16,512
						5	$136,512	$120,000	$16,512
Working						Working
The cash inflow from the sale of the latex moulding machine						The depreciation schedule for the new machine using 5 year MACRS
Sale value as of now	$270,000.00					Year	Depreciable value	Depreciation rates	Depreciation
Less : Book value as of now	$600,000.00					1	$1,185,000	20%	$237,000
Loss on Sale	-$330,000.00					2	$1,185,000	32%	$379,200
Tax benefit @ 35% on Loss	$117,250.00					3	$1,185,000	19.20%	$227,520
Cash Inflow [Sale value + Tax benefit]	$387,250.00					4	$1,185,000	11.52%	$136,512
						5	$1,185,000	11.52%	$136,512
						6	$1,185,000	5.76%	$68,256
						Answer g
						Incremental net cash flows in Years 1 through 5
						Year	Depreciation Tax shield	After tax savings = Annual savings x(1-tax rate)	After tax salvage value of new machine	Cash flow
						1	$40,950	$165,750		$206,700
						2	$90,720	$165,750		$256,470
						3	$37,632	$165,750		$203,382
						4	$5,779	$165,750		$171,529
						5	$5,779	$165,750	$92,140	$263,669
						Working
						Determination of depreciation tax shield on depreciation difference
						Year	Change in depreciation	Tax shield @ 35% of change
						1	$117,000	$40,950
						2	$259,200	$90,720
						3	$107,520	$37,632
						4	$16,512	$5,779
						5	$16,512	$5,779
						Calculation of after tax salvage value of new machine at the end of Year 5
						Sale value of new machine		$105,000
						Less : Book value		$68,256
						Gain on sale of new machine		$36,744
						Tax @ 35% of Gain		$12,860
						After tax salvage value [Sale value - Tax]		$92,140
						Answer i - Calculation of NPV
						Year	Cash flow	Discount factor @ 12%	Present Value
						0	-$797,750	1	-$797,750
						1	$206,700	0.892857143	$184,554
						2	$256,470	0.797193878	$204,456
						3	$203,382	0.711780248	$144,763
						4	$171,529	0.635518078	$109,010
						5	$263,669	0.567426856	$149,613
						NPV			-$5,354
						The firm should not purchase the new machine as it has negative NPV.
						NPV =	-$5,354