A machine currently in use was originally purchased 2 years ago for $40,000. The machine is being depreciated under straight-line depreciation method and it has 3 years of usable life remaining. The current machine can be sold today to net of $42,000 after removal and cleanup costs. A new machine can be purchased at a price of $140,000 and it has a 3 years usable life, it requires $10,000 to install. The straight-line depreciation method is also used for the new machine. If the new machine was acquired, the investment in accounts receivable would be expected to rise by $10,000, the inventory investment will increase by $25,000 and accounts payable will increase by $15,000. Earnings before depreciation, interest and taxes are expected to be $70,000 for each of the next 3 years with the old machine and to be $120,000 in the first year and $130,000 in the second and third years with the new machine. At the end of the 3 years, the market value of the old and new machine will equal zero, but the new machine could be sold to net $35,000 before taxes. The firm is subject to 40% tax rate.

Answer the following questions using the Straight Line approach as method of depreciation with no salvage value.

Requirement:

a. Determine the initial investment associated with the proposed replacement decision.

b. Calculate the incremental operating cash inflows for years 1 to 4 associated with the proposed replacement. (Note: Only depreciation cash flows must be considered in year 4.)

c. Calculate the terminal cash flow associated with the proposed replacement decision. (Note: This is at the end of year 3.)

d. Depict on a time line the relevant cash flows found in parts a, b, and c that are associated with the proposed replacement decision, assuming that it is terminated at the end of year 3.