Question

The Bigbee Bottling Company is considering the replacement of one of its bottling machines with a newer and more efficient one. The old machine has a book value of $300,000 and will be depreciated toward a zero salvage value using the straight line depreciation method over its remaining 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 $160,000. The new machine has a purchase price of $1,150,000, and has an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $145,000 at the end of year 5. It is expected that the replacement will economize on electric power usage, labor, and repair costs; hence, an annual savings of $420,000 will be realized if the new machine is installed. At the time of replacement, the company will need to increase its inventory by $35,000 but expects no additional net working capital requirements in later years. The project has a 10% cost of capital. The company’s marginal tax rate is 35%. The annual recovery allowance percentage for a I5-year MACRS class asset is 20.0%, 32.0%, 19.0%, 12.0%, 11.0%, 6.0% for each of the six-year period. Question: Should the Bigbee Bottling Company replace the old bottling machine with a new one? Defend your answer by filling up the “Bigbee Project Analysis Worksheet” in the attached Excel sheet.   I am looking for the solved problem. I am struggling with the after tax decrease in cost and the tax savings from depreciation

Answer 1