Question

Relevant cash flows—No terminal value   Central Laundry and Cleaners is considering replacing an existing piece of machinery with a more sophisticated machine. The old machine was purchased 3 years ago at a cost of $54,300​, and this amount was being depreciated under MACRS using a​ 5-year recovery period. The machine has 5 years of usable life remaining. The new machine that is being considered costs $76,200 and requires $4,200 in installation costs. The new machine would be depreciated under MACRS using a​ 5-year recovery period. The firm can currently sell the old machine for $54,800 without incurring any removal or cleanup costs. The firm is subject to a tax rate of 40%.

The revenues and expenses​ (excluding depreciation and​interest) associated with the new and the old machines for the next 5 years aregiven in the table

	New machine			Old machine
Year	Revenue	Expenses ​(excluding depreciation and​ interest)		Revenue	Expenses ​(excluding depreciation and​ interest)
1	$749,400	$719,100		$673,400	$659,800
2	749,400	719,100		675,400	659,800
3	749,400	719,100		679,400	659,800
4	749,400	719,100		677,400	659,800
5	749,400	719,100		673,400	659,800

. ​(Table

Percentage by recovery​ year*
Recovery year	3 years	5 years	7 years	10 years
1	33​%	20​%	14​%	10​%
2	45​%	32​%	25​%	18​%
3	15​%	19​%	18​%	14​%
4	7​%	12​%	12​%	12​%
5		12​%	9​%	9​%
6		5​%	9​%	8​%
7			9​%	7​%
8			4​%	6​%
9				6​%
10				6​%
11				4​%
Totals	100​%	100​%	100​%	100​%

contains the applicable MACRS depreciation​ percentages.) Note: The new machine will have no terminal value at the end of 5 years.

a. Calculate the initial investment associated with replacement of the old machine by the new one.

b. Determine the incremental operating cash inflows associated with the proposed replacement.​ (Note: Be sure to consider the depreciation in year​ 6.)

c. Depict on a time line the relevant cash flows found in parts​(a​) and ​(b​) associated with the proposed replacement decision.

a. Calculate the initial investment associated with replacement of the old machine by the new one.

Calculate the initial investment​ below:  ​(Round to the nearest​ dollar.)

Cost of new asset	$	76,200
Installation costs		4,200
Total cost of new asset			$	80,400
Proceeds from sale of old asset	$	(54,800)
Tax on sale of old asset		15,621
Total proceeds, sale of old asset			$	(39,179)
Initial investment			$	41,221

b. Determine the incremental operating cash inflows associated with the proposed replacement.​ (Note: Be sure to consider the depreciation in year​ 6.)

Calculate the cash flows with the old machine​ below:  ​(Round to the nearest​ dollar.)

Year	1
Profit before depreciation and taxes	$
Depreciation	$
Net profit before taxes	$
Taxes	$
Net profit after taxes	$
Operating cash inflows	$

Answer 1

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