Dave's Drilling is considering the acquisition of new manufacturing equipment that has the same capacity as the current equipment. The new equipment will provide $150,000 of annual operating efficiencies in direct and indirect labor, direct material usage, indirect supplies, and power during its estimated 4-year life.

The new equipment costs $300,000 and would be purchased at the beginning of the year. Given the time of installation and training, the equipment will not be fully operational until the second quarter of the year it is purchased. Thus, only 60 percent of the estimated annual savings can be obtained in the year of purchase. Dave's Drilling will incur a one-time expense of $80,000 to transfer the production activities from the old equipment to the new. No loss of sales will occur, however, because the plant is large enough to install the new equipment without disrupting operations of the current equipment. Although the current equipment is fully depreciated and carried at zero book value, its condition is such that it could be used an additional 4 years. A salvage dealer will remove the old equipment and pay Dave's Drilling $5,000 for it.

The company currently leases its manufacturing plant for $60,000 per year. The lease, which will have 4 years remaining when the equipment installation would begin, is not renewable. The company must remove any equipment in the plant at the end of the lease term. Cost of equipment removal is expected to equal the salvage value of either the old or the new equipment at the time of removal.

Dave's Drilling uses the sum-of-the-years'-digits depreciation method for tax purposes.

A full year's depreciation is taken in the first year an asset is put into use. The company is subject to a 40 percent income tax rate and requires an after-tax return of at least 11 percent on an investment.

a. Calculate the annual incremental after-tax cash flows for the company's proposal to acquire the new manufacturing equipment.

b. Calculate the net present value of the company's proposal to acquire the new manufacturing equipment using the cash flows calculated in (a) and indicate what action Dave's management should take. Assume all recurring cash flows occur at the end of the year.