Question

The Bigbee Bottling Company is contemplating the replacement of one of its bottling machines with a newer and more efficient one. The old machine has a book value of $600,000 and a remaining useful 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 $280,000. The old machine is being depreciated by $120,000 per year, using the straight-line method.

The new machine has a purchase price of $1,125,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $160,000. The applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. It is expected to economize on electric power usage, labor, and repair costs, as well as to reduce the number of defective bottles. In total, an annual savings of $205,000 will be realized if the new machine is installed. The company's marginal tax rate is 35%, and it has a 12% WACC.

1. What initial cash outlay is required for the new machine? Round your answer to the nearest dollar. Negative amount should be indicated by a minus sign.
   $
   
2. Calculate the annual depreciation allowances for both machines and compute the change in the annual depreciation expense if the replacement is made. Round your answers to the nearest dollar.

   Year	Depreciation Allowance, New	Depreciation Allowance, Old	Change in Depreciation
   1	$	$	$
   2
   3
   4
   5

3. What are the incremental net cash flows in Years 1 through 5? Round your answers to the nearest dollar.

   Year 1	Year 2	Year 3	Year 4	Year 5
   $	$	$	$	$

Answer 1

a)	INITIAL INVESTMENT:
	Purchase price of the new machine	$ 11,25,000
	Less: After tax sale value of old machine = 280000+(600000-280000)*35% =	$    3,92,000
	Initial investment	$    7,33,000
b)	Year	Depreciation Allowance, New	Depreciation Allowance, Old	Change in Depreciation
	1	$    2,25,000	$     1,20,000	$      1,05,000
	2	$    3,60,000	$     1,20,000	$      2,40,000
	3	$    2,13,750	$     1,20,000	$          93,750
	4	$    1,35,000	$     1,20,000	$          15,000
	5	$    1,23,750	$     1,20,000	$            3,750
c)		0	1	2	3	4	5
	Annual savings after tax [205000*(1-35%)]		$     1,33,250	$      1,33,250	$    1,33,250	$   1,33,250	$ 1,33,250
	Tax shield from depreciation at 35%		$         36,750	$          84,000	$        32,813	$         5,250	$        1,313
	Incremental OCF		$     1,70,000	$      2,17,250	$    1,66,063	$   1,38,500	$ 1,34,563
	Capital expenditure	$    7,33,000
	After tax salvage value = 160000-(160000-1125000*6%)*35% =						$ 1,27,625
	Incremental net cash flows	$   -7,33,000	$     1,70,000	$      2,17,250	$    1,66,063	$   1,38,500	$ 2,62,188