DeYoung Entertainment Enterprises is considering replacing the latex molding machine it uses to fabricate rubber chickens with a newer, more efficient model. The current machine has a book value of $450,000 and is being depreciated by $90,000 per year over its remaining useful life of 5 years. The current machine would be worn out and worthless in 5 years, but DeYoung can sell it now to a Halloween mask manufacturer for $135,000. If DeYoung doesn’t replace the current machine, it will have no salvage value at the end of its useful life. The new machine has a purchase price of $775,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $105,000. The applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. Being highly efficient, it is expected to economize on electric power usage, labor, and repair costs, and, most importantly, to reduce the number of defective chickens. In total,
an annual savings of $185,000 will be realized if the new machine is installed. The company’s marginal tax rate is 25%, and the project cost of capital is 12%.
a. What is the after-tax initial cash flow if the new machine is purchased and the old one is replaced?
b. What is the incremental depreciation tax shield each year (i.e., the change taxes due to the change in depreciation expenses) if the replacement is made?
c. What is the after-tax salvage value at Year 5?
d. What are the total incremental project cash flows in Years 0 through 5? What is the NPV?