Analyzing cash flows from alternatives. Savient Company is considering replacing some machinery. The old machinery has book value and tax basis of S 10.000. Its current market value is $5,000. Savient does not have the alternative of just selling the old machinery now. It must either use it for another year or replace it. Savient has been depreciating the old equipment on a straight-line basis at the rate of $10,000 per year. If Savient retains the machinery it will depreciate the remaining tax basis over I year and the financial book value over 3 years. The machinery will have no market value 1 year hence.

Savient can acquire new machinery for $30,000. which will produce $10,000 of cash savings at the end of the first year. The new machinery will produce cash savings at the end of Year 2 that is 5 percent greater than at the end of Year 1 . a nd at the end of Year 3 the savings will be 5 percent greater than at the end of Year 2. The new machinery will have a 3-year life. Savient will depreciate the equipment on a straight-line basis over 3 years for both tax and financial reporting purposes. It will sell the machinery for $8,000 at the end of Year 3 but will ignore salvage value in tax depreciation computations.

Savient pays income taxes at the rate of 40 percent for both ordinary income and for capital gains. The cost of capital for the new machinery, after taxes, is 12 percent per year. Savient earns sufficient taxable income that it can deduct from its taxes payable at the beginning of Year 1 ( = end of Year 0) the loss from disposition of the old machinery at the beginning of Year 1 ( = end of Year 0).

Analyze the present value of the cash Mow s of the alternatives and make a recommendation toS avient Company.