Question
3. (18 points) Kirksville Corporation is considering replacing one of its machines with a new, more efficient machine. The old machine was bought at $420,000
3. (18 points) Kirksville Corporation is considering replacing one of its machines with a new, more efficient machine. The old machine was bought at $420,000 four years ago and can currently be sold for $200,000. The old machine is being depreciated on a simplified straight-line basis down to a salvage value of $25,000 in the next 6 years. The replacement machine would cost $540,000, and have an expected life of 6 years, after which it could be sold for $60,000. Because of reductions in defects and material savings, the new machine would produce cash benefits of $150,000 per year before depreciation and taxes.
Also, the replacement requires an initial investment in spare parts inventory of $25,000, along with an additional $20,000 in inventory for each succeeding year of the project. The inventory will be recovered when the project ends. Assume simplified straight-line depreciation, a 20 percent marginal tax rate, and a required rate of return of 5 percent.
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(6 points) What is the initial outlay associated with this project?
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(3 points) What are the operating cash flows associated with this project?
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(6 points) What is the terminal cash flow in year 6?
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(3 points) Should the old machine be replaced?
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