Homework SourseEnterprises is considering replacing the latex molding machi
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 $270,000. 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 $1,185,000, 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 $245,000 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%.
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.
$
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.
What are the incremental net cash flows in Years 1 through 5? Do not round intermediate calculations. Round your answers to the nearest dollar.
Should the firm purchase the new machine?
NPV: $
Year | Depreciation Allowance, New | Depreciation Allowance, Old | Change in Depreciation |
| 1 | $ | $ | $ |
| 2 | $ | $ | $ |
| 3 | $ | $ | $ |
| 4 | $ | $ | $ |
| 5 | $ | $ | $ |
Solution
Book value of old machine
800000
proceeds from sale of old machine
270000
loss on sale of old machine
530000
tax benefit on loss on sale of old machine
530000*35%
185500
net proceeds with tax benefits
270000+185500
455500
1-
Initial net cash flow
cost of new machine
1185000
less net proceeds with tax benefits of old machine
455500
Initial net cash flow
729500
Year
cost of new machine
MACRS rate
Annual Depreciation
Annual depreciation on old machine
incremental depreciation
1
1185000
20%
237000
160000
77000
2
1185000
32%
379200
160000
219200
3
1185000
19.20%
227520
160000
67520
4
1185000
11.52%
136512
160000
-23488
5
1185000
11.52%
136512
160000
-23488
Year
0
1
2
3
4
5
Initial net cash flow
-729500
annual saving
245000
245000
245000
245000
245000
less incremental depreciation
77000
219200
67520
-23488
-23488
after depreciation saving
168000
25800
177480
268488
268488
after tax savings = after depreciation savings*(1-.35)
109200
16770
115362
174517.2
174517.2
annual operating saving = after tax savings+incremental depreciation
186200
235970
182882
151029.2
151029.2
tax benefit on disposal of new machine
0
0
0
0
23889.6
net annual operating savings
-729500
186200
235970
182882
151029.2
174918.8
present value of cash flow = cash flow/(1+r)^n r=15%
-729500
161913.0435
178427.2
120247.9
86351.44
75088.2
NPV = sum of present value of net operating savings
-107472.21
npv is negative so machine should not be purchased
BOOK value of new machine at the end of year 5
1185000*5.76%
68256
tax benefit on disposal of new machine
68256*.35
23889.6
| Book value of old machine | 800000 | |||||
| proceeds from sale of old machine | 270000 | |||||
| loss on sale of old machine | 530000 | |||||
| tax benefit on loss on sale of old machine | 530000*35% | 185500 | ||||
| net proceeds with tax benefits | 270000+185500 | 455500 | ||||
| 1- | ||||||
| Initial net cash flow | ||||||
| cost of new machine | 1185000 | |||||
| less net proceeds with tax benefits of old machine | 455500 | |||||
| Initial net cash flow | 729500 | |||||
| Year | cost of new machine | MACRS rate | Annual Depreciation | Annual depreciation on old machine | incremental depreciation | |
| 1 | 1185000 | 20% | 237000 | 160000 | 77000 | |
| 2 | 1185000 | 32% | 379200 | 160000 | 219200 | |
| 3 | 1185000 | 19.20% | 227520 | 160000 | 67520 | |
| 4 | 1185000 | 11.52% | 136512 | 160000 | -23488 | |
| 5 | 1185000 | 11.52% | 136512 | 160000 | -23488 | |
| Year | 0 | 1 | 2 | 3 | 4 | 5 |
| Initial net cash flow | -729500 | |||||
| annual saving | 245000 | 245000 | 245000 | 245000 | 245000 | |
| less incremental depreciation | 77000 | 219200 | 67520 | -23488 | -23488 | |
| after depreciation saving | 168000 | 25800 | 177480 | 268488 | 268488 | |
| after tax savings = after depreciation savings*(1-.35) | 109200 | 16770 | 115362 | 174517.2 | 174517.2 | |
| annual operating saving = after tax savings+incremental depreciation | 186200 | 235970 | 182882 | 151029.2 | 151029.2 | |
| tax benefit on disposal of new machine | 0 | 0 | 0 | 0 | 23889.6 | |
| net annual operating savings | -729500 | 186200 | 235970 | 182882 | 151029.2 | 174918.8 |
| present value of cash flow = cash flow/(1+r)^n r=15% | -729500 | 161913.0435 | 178427.2 | 120247.9 | 86351.44 | 75088.2 |
| NPV = sum of present value of net operating savings | -107472.21 | |||||
| npv is negative so machine should not be purchased | ||||||
| BOOK value of new machine at the end of year 5 | 1185000*5.76% | 68256 | ||||
| tax benefit on disposal of new machine | 68256*.35 | 23889.6 |
