Question
Central Laundry and Cleaners is considering replacing an existing piece of machinery with a more sophisticated machine. The old machine was purchased 3 years ago
Central Laundry and Cleaners is considering replacing an existing piece of machinery with a more sophisticated machine. The old machine was purchased 3 years ago at a cost of $53,100, and this amount was being depreciated under MACRS using a 5-year recovery period. The machine has 5 years of usable life remaining. The new machine that is being considered costs $76,600 and requires $4,100 in installation costs. The new machine would be depreciated under MACRS using a 5-year recovery period. The firm can currently sell the old machine for $54,700 without incurring any removal or cleanup costs. The firm is subject to a tax rate of 40%.
The revenues and expenses (excluding depreciation and interest) associated with the new and the old machines for the next 5 years are given in the table.
New Machine | Old Machine | |||
Year | Revenue | Expenses (excluding depr. and interest) | Revenue | Expenses (excluding depr. and interest) |
1 | $749,100 | $720,700 | $674,700 | $659,800 |
2 | $749,100 | $720,700 | $676,700 | $659,800 |
3 | $749,100 | $720,700 | $680,700 | $659,800 |
4 | $749,100 | $720,700 | $678,700 | $659,800 |
5 | $749,100 | $720,700 | $674,700 | $659,800 |
(The table below contains the applicable MACRS depreciation percentages.) Note:
The new machine will have no terminal value at the end of 5 years.
Percentage by recovery year | ||||
Recovery year | 3 years | 5 years | 7 years | 10 years |
1 | 33% | 20% | 14% | 10% |
2 | 45 | 32 | 25 | 18 |
3 | 15 | 19 | 18 | 14 |
4 | 7 | 12 | 12 | 12 |
5 | 12 | 9 | 9 | |
6 | 5 | 9 | 8 | |
7 | 9 | 7 | ||
8 | 4 | 6 | ||
9 | 6 | |||
10 | 6 | |||
11 | 4 | |||
Totals | 100% | 100% | 100% | 100% |
a. Calculate the initial investment associated with replacement of the old machine by the new one.
b. Determine the incremental operating cash inflows associated with the proposed replacement. (Note: Be sure to consider the depreciation in year 6.)
c. Depict on a time line the relevant cash flows found in parts (a) and (b) associated with the proposed replacement decision.
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