=+18-33 KKK Replacement of a machine, income taxes, sensitivity (CMA, adapted) OBJECTIVES 3, 4, 8 Kingaroy’s Nuttery produces peanut butter. The company has a grinding machine that has been in use for three years. On 1 January 2015, Kingaroy’s Nuttery is considering the purchase of a new grinding machine. Kingaroy’s Nuttery has two options: (1) continue using the old machine; or (2) sell the old machine and purchase a new machine. The seller of the new machine isn’t offering a trade-in. The following information has been obtained:

Chapter 18: Capital budgeting and cost analysis 721 M18_HORN3377_02_LT_C18.indd 721 2/09/13 4:03 PM Old machine New machine senihcam fo tsoc esahcrup laitinI $120 000

)sraey( etad noitisiuqca from efil lufesU 7

$

$

$

$

$

Terminal disposal value at the end of useful life on 31 Dec. 2018, assumed for depreciation purposes 15 000 Expected annual cash operating costs:

tsoc elbairaV per jar of peanut butter 0.20 stsoc dexif latoT 22 500 Depreciation method for tax purposes Estimated disposal value of machines:

1 January 2015 60 000 31 December 2018 10 500 Expected jars of peanut butter made and sold each year 1

2 3

4 5

6 7

8 9

10 11 12 13 A B C

$180 000 4

30 000 0.14 21 000 Straight line 180 000 30 000 450 000 Straight line 450 000

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$

$

$

$

Kingaroy’s Nuttery is subject to a 30% income tax rate. Assume that any gain or loss on the sale of machines is treated as an ordinary tax item and will affect the taxes paid by Kingaroy’s Nuttery in the year in which it occurs. Kingaroy’s Nuttery’s after-tax required rate of return is 12%. Assume all cash flows occur at year-end except for initial investment amounts.

Required 1 You have been asked whether Kingaroy’s Nuttery should buy the new machine. To help in your analysis, calculate the following:

a one-time after-tax cash effect of disposing of the old machine on 1 January 2015