) The Wolf Pack Company is considering replacing an existing machine with a newe

Question

) The Wolf Pack Company is considering replacing an existing machine with a newer, more efficient version. The old machine was purchased 2 years ago at a cost of $40,000, and this amount was being depreciated under MACRS using a 3-year recovery period. The machine has 3 years of usable life remaining. The new machine that is being considered costs $75,000 and requires $7,500 in installation costs. The new machine would also be depreciated under the MACRS 3-year recovery period. The firm can sell the old machine for $12,500 without incurring any removal or cleanup costs. The firm pays a tax rate of 40% on ordinary income. The revenues and expenses (excluding depreciation) associated with the old and new machine for the next 3 years are listed in the table below:

                                    New Machine                                       Old Machine                           

                        Year     Revenue           Expenses                      Revenue           Expenses

                            1      $575,000         $525,000                     $475,000         $460,000

                            2      625,000         535,000                     500,000         465,000

                            3      650,000         550,000                     550,000         478,000

                           

calculate the initial outlay associated with the replacement of the old machine  

determine the incremental, after-tax operating cash inflows associated with the proposed replacement (be sure to include the relevant depreciation flow in year 4)

Explanation / Answer

Initial outlay assoaciated with the the Project: Machine cost 75000+ 7500 = 82500 ( Tax benefit on sale of old machine would not be reduced as tax rate is only for ordinary income and this income is from the sale of old machine

Incremental Cash flows

Calculation of incremental dep:

calculation of dep on old machine:

MACRS DEPRECIATION BY CLASS OF PROPERTY

Depriciattion for new asset

Calculation of incremental dep:

calculation of dep on new machine:

82500

MACRS DEPRECIATION BY CLASS OF PROPERTY

Cash flow from new machine cash flow from old machine incremental cash flow Incremental dep cash flow after dep tax cash flow after tax 50000 15000 35000 21573 13427 5370.8 8056.2 90000 35000 55000 33707.25 21292.75 8517 12775.75 100000 72000 28000 12218.25 15781.75 6312.7 9469 6113.25 -6113 -2445

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