Company Sarah plans to replace one of its knitting machines with a newer and more efficient model. The old knitting machine was bought 4 years ago for $750,000, and the company paid an additional $20,000 for installation and insurance. The company has been depreciating this machine to a value of 0 using the straight-line depreciation method over 8 years. However, the old knitting machine can still be used for 6 more years in the production process and Company Sarah expects to sell this old machine for $60,000 6 years from today. However, if the company decides to replace the old machine now, it can sell the old machine to another firm in the industry for $440,000.

The new machine has a purchase price of $1,200,000. The company will depreciate this new machine to a value of 0 using the straight-line method over 8 years as well. Company Sarah can also use this new machine for six years in its production process. Company Sarah expects that this new machine will have a resale value of $180,000 after six years. This new machine is expected to decrease electricity, labor, and repair costs, and the number of defective fabrics produced. Because of all these reductions, annual cost savings of $230,000 per year will be realized in years 1 through 3 if the new machine is purchased to replace the old one. The annual cost savings will decrease to $210,000 per year for years 4 through 6. Furthermore, because of the lower breakage of the new machine, the company can reduce the inventory it carries by $25,000 at time 0 and keep it at that level for the duration of this project. The companys tax rate is 35% and the required rate of return on projects like this is 14%.

a. Calculate the operating cash flows for years 1 through 6.

b. Calculate the net capital spending at times 0 and 6.

c. Calculate the change in net working capital from year 0 to 6.

d. Decide if Company Sarah should replace the old machine with the new one and state why.