Speedy Auto Wash is contemplating the purchase of a new high-speed washer to rep

Question

Speedy Auto Wash is contemplating the purchase of a new high-speed washer to replace the existing washer. The existing washer was purchased two years ago at an installed cost of $150,000; it was being depreciated under MACRS using a 5-year recovery period. The existing washer is expected to have a usable life of five more years. The new washer costs $230,000 and requires $10,000 n installation costs; it has a 5-year usable life and would be depreciated under MACRS using a 5-year recovery period. The existing washer can currently be sold for $160,000 without incurring any removal or cleanup costs. To support the increased business resulting from purchase of the new washer, accounts receivable would increase by $90,000, inventories by $70,000, and accounts payable by $107,000. At the end of five years, the existing washer is expected to have a market value of zero; the new washer could be sold to net $58,000 after removal and cleanup costs and before taxes. The firm pays taxes at a rate of 30% on both ordinary income and capital gains. The estimated profits before depreciation and taxes over the five years, for both the new and the existing washer, are shown in the following table. a. Calculate the initial cash outflow associated with the replacement of the existing washer with the new one $. b. Determine the incremental cash flows associated with the proposed washer replacement. Be sure to consider the depreciation in year 6. Take into account net working capital recovery. Round your answers to the nearest cent. Year 1 2 3 4 5 Difference $ $ $ $ c. Determine the terminal cash flow expected at the end of year 5 from the proposed washer replacement. Round your answer to the nearest cent.

Explanation / Answer

Answer: a

Total cost of installation=Cost of new washer+ Installation cost

=$230000+$10000=$240000

Total installed cost $240,000.

Proceeds from sale of existing washer $160,000

Less tax on sale of existing washer:

Sale Price = $160000

– Book Value (1– .20 – .32) × $150,000 =72000

Gain on sale of existing washer= $ 88,000

Tax on sale of existing washer =$88000*0.30

=$26400

After tax proceeds from sale of existing washer (160000-26400)=(133600)

+ Initial working capital investment

(Increase in current assets: Accounts receivable $ 90,000 Inventories 70,000 Total current assets increase $160,000 Less increase in current liabilities: Accounts Payable $107,000 Total current liabilities increase 107,000

Initial working capital investment= 53,000

INITIAL CASH OUTFLOW =$240000-133600+53000=$159400

Answer:b

Note that the first 3 years of depreciation have already been taken on the existing washer.

Answer:c

5 Years MACRS % Installed Cost Depreciation 20 150000 30000 32 150000 48000 19.2 150000 28800 11.52 150000 17280 11.52 150000 17280 5.76 150000 8640 Total 150000

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