(Capital Budgeting- Question)

Precision Instruments operates a machine that was purchased at a cost of $580,000 three years ago. Its current market value is $240,000 less than the original purchase price. An improved version of the equipment is now available for $600,000. The firm has spent $20,000 on a study examining the feasibility of replacing the old machine with the new machine and found that the new machine is capable of performing the same functions as the old one. Both machines belong to the same CCA class (CCA rate: d = 30%) and have an expected remaining useful life of four years, but while the older machine will be worth only $60,000 by that time, the new machine can be sold for $250,000 in four years. The vendor will charge $5,000 for the installation of the new machine and the removal of the old one, and this amount must be capitalized and added to the CCA asset pool. Management believes that the company will have other assets in the same class in four years when the new equipment would be sold. The cost of operating the old machine is expected to be $100,000 next year (i.e. t = 1) with this cost increasing at 4% per year over the next three years. Management estimates that the cost of operating the new machine will be $50,000 in its first year of operation (i.e. t = 1) and will increase at the same rate as the old machine. In addition, the more efficient new machine will immediately reduce the amount of net working capital (NWC) required by $30,000. The firms marginal tax rate is 35% and the required rate of return is 12%. Should the firm replace the machine?

a. What is the initial cash outlay (the total cash flow at t = 0)?

b. What is the first years cash flow (excluding the CCA Tax Shield)?

c. What is the last years cash flow (excluding the CCA Tax Shield)?

d. What is the year 1 CCA? e. What is the year 3 CCA?

f. What is the PV CCA TS?

g. What is the NPV of the replacement project?

h. Should Precision Instruments replace the old machine with the new one? (Yes/No)