Consider the following scenario and calculate beginning UCC, CCA, ending UCC, after-tax incremental cash flow, and CCA tax shield every year. Annual incremental cash flow includes the lost revenue of the old machine (cash outflow), the saving of maintenance of the old machine (cash inflow), and the maintenance of the new machine (cash outflow). Then decide whether a newspaper, Weekday, should replace its current printing press with a new one.
Currently Weekday has a printing press in its plant that costs $5,000 a year in maintenance. The maintenance costs are expected to increase by $1,000 a year for the next five years. At the end of the five years, the machine will be scrapped and the salvage value will be zero. The press was fully depreciated eight years ago. The current press has a unique capability to print very large certificates in addition to the regular printing. The revenue from the certificate business is expected to be $1,500 per year for the next five years.
A replacement machine is available at a cost of $25,000 with a life expectancy of five years. At the end of the five years, the salvage value is expected to be $5,000. The CCA rate for the machine is 20 percent. Annual maintenance costs of the new machine are $500 per year.
The company is expected to be very profitable in the future. The real risk-free rate is 2-percent; inflation is expected to remain at 3 percent for the next five years, and the appropriate real discount rate for risky cash flows is 7 percent. The tax rate is 34 percent.