REPLACEMENT ANALYSIS The Bigbee Bottling Company is contemplating the replacemen
ID: 2402350 • Letter: R
Question
REPLACEMENT ANALYSIS
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 $155,000. 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 $240,000 will be realized if the new machine is installed. The company's marginal tax rate is 35%, and it has a 12% WACC.
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.
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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.
What are the incremental net cash flows in Years 1 through 5? Round your answers to the nearest dollar.
Explanation / Answer
Old Machine Book Value $600,000 No of Useful Life 5 yrs Can sell it now at $280000 Depreciation per year $120,000 Purchase price of new machine 1125000 No of Useful Life 5 Salvage value $155,000 Depreciation rates 20,32,19,12,11,6 Annual Savings $240,000 Tax Rate 35% WACC 12% 1 What initial cash outlay is required for the new machine Cost of New Machine -1125000 Sale of Old machine 280000 Tax Savings on old machine 112000 (600000-280000)*35% Initial Cash outlay -733000 2) Calculate the annual depreciation allowances for both machines and compute the change in the annual depreciation expense if the replacement is made. Year Depreciation allowance, New Depreciation allowance, Old Change in depreciation 1 225000 120000 105000 2 360000 120000 240000 3 213750 120000 93750 4 135000 120000 15000 5 123750 120000 3750 457500 Year 1 2 3 4 5 Total $ 20 32 19 12 11 94 Dep (1125000*rate) 225000 360000 213750 135000 123750 1057500 1125000-1057500 67500 3) Year 1 Year 2 Year 3 Year 4 Year 5 Savings 240000 240000 240000 240000 240000 Differential Depreciation 105000 240000 93750 15000 3750 EBT 135000 0 146250 225000 236250 Less : Tax @ 40% 54000 0 58500 90000 94500 EAT 81000 0 87750 135000 141750 Add: Diff Dep 105000 240000 93750 15000 3750 Cash flow 186000 240000 181500 150000 145500 Opearting Cash flow in year 5 145500 Cash SV of new Machine 155000 Tax on profit on Sale (155000 - 67500)*0.40 -35000 Cash Flow 265500 Year Cash flow Incremental cash flow Year 1 186000 Year 2 240000 54000 Year 3 181500 -58500 Year 4 150000 -31500 Year 5 265500 115500
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