Problem 3: A machine currently in use was originally purchased 2 years ago for $40,000. The machine is being depreciated under MACRS using a 5-year recovery period; it has 3 years of usable life remaining. The current machine can be sold today to net $42,000 after removal and cleanup costs. A new machine, using a 3-year MACRS recovery period, can be purchased at a price of $140,000. It requires $10,000 to install and has a 3-year usable life. If the new machine is acquired, the investment in accounts receivable will be expected to rise by $10,000, the inventory investment will increase by $25,000, and accounts payable will increase by $15,000. Earnings before depreciation, interest, and taxes are expected to be $70,000 for each of the next 3 years with the old machine and to be $120,000 in the first year and $130,000 in the second and third years with the new machine. At the end of 3 years, the market value of the old machine will equal zero, but the new machine could be sold to net $35,000 before taxes. The firm is subject to a 40% tax rate. Percentage by recovery year 5 ycars Recovery year 3 усаrs 7 усars 10 ycars 33% 20% 14% 10% 45 32 25 18 3. 15 19 18 14 12 12 12 12 7. 6. 6. 10 11 Totals 100% 100% 100% 100% a.Determine the initial investment associated with the proposed replacement decision. b. Calculate the incremental operating cash inflows for years 1 to 4 associated with the proposed replacement. (Note: Only depreciation cash flows must be considered in year 4.) c. Calculate the terminal cash flow associated with the proposed replacement decision. (Note: This is at the end of year 3.)
Problem 3: A machine currently in use was originally purchased 2 years ago for $40,000. The machine is being depreciated under MACRS using a 5-year recovery period; it has 3 years of usable life remaining. The current machine can be sold today to net $42,000 after removal and cleanup costs. A new machine, using a 3-year MACRS recovery period, can be purchased at a price of $140,000. It requires $10,000 to install and has a 3-year usable life. If the new machine is acquired, the investment in accounts receivable will be expected to rise by $10,000, the inventory investment will increase by $25,000, and accounts payable will increase by $15,000. Earnings before depreciation, interest, and taxes are expected to be $70,000 for each of the next 3 years with the old machine and to be $120,000 in the first year and $130,000 in the second and third years with the new machine. At the end of 3 years, the market value of the old machine will equal zero, but the new machine could be sold to net $35,000 before taxes. The firm is subject to a 40% tax rate. Percentage by recovery year 5 ycars Recovery year 3 усаrs 7 усars 10 ycars 33% 20% 14% 10% 45 32 25 18 3. 15 19 18 14 12 12 12 12 7. 6. 6. 10 11 Totals 100% 100% 100% 100% a.Determine the initial investment associated with the proposed replacement decision. b. Calculate the incremental operating cash inflows for years 1 to 4 associated with the proposed replacement. (Note: Only depreciation cash flows must be considered in year 4.) c. Calculate the terminal cash flow associated with the proposed replacement decision. (Note: This is at the end of year 3.)
Chapter11: Cash Flow Estimation And Risk Analysis
Section: Chapter Questions
Problem 10P
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Transcribed Image Text:Problem 3: A machine currently in use was originally purchased 2 years ago for $40,000. The machine is
being depreciated under MACRS using a 5-year recovery period; it has 3 years of usable life remaining.
The current machine can be sold today to net $42,000 after removal and cleanup costs. A new machine,
using a 3-year MACRS recovery period, can be purchased at a price of $140,000. It requires $10,000 to
install and has a 3-year usable life. If the new machine is acquired, the investment in accounts receivable
will be expected to rise by $10,000, the inventory investment will increase by $25,000, and accounts
payable will increase by $15,000. Earnings before depreciation, interest, and taxes are expected to be
$70,000 for each of the next 3 years with the old machine and to be $120,000 in the first year and
$130,000 in the second and third years with the new machine. At the end of 3 years, the market value of
the old machine will equal zero, but the new machine could be sold to net $35,000 before taxes. The
firm is subject to a 40% tax rate.
Percentage by recovery year
Recovery year
3 усаrs
5 ycars
7 усаrs
10 ycars
33%
20%
14%
10%
45
32
25
18
3.
15
19
18
14
4
12
12
12
12
9.
6.
6.
10
11
Totals
100%
100%
100%
100%
a.Determine the initial investment associated with the proposed replacement decision.
b. Calculate the incremental operating cash inflows for years 1 to 4 associated with the proposed
replacement. (Note: Only depreciation cash flows must be considered in year 4.)
c. Calculate the terminal cash flow associated with the proposed replacement decision. (Note: This is at
the end of year 3.)
d. Depict on a time line the relevant cash flows found in parts a, b, and c that are associated with the
proposed replacement decision, assuming that it is terminated at the end of year 3.
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