De Young Entertainment Enterprises is considering replacing the latex molding machine it uses to fabricate rubber chickens with a newer, more efficient model. The old machine has a book value of $400,000 and a remaining useful life of 5 years. The current machine would be worn out and worthless in 5 years, but De Young can sell it now to a Halloween mask manufacturer for $120,000. The old machine is being depreciated by $80,000 per year for each year of its remaining life. The new machine has a purchase price of $850,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $105,000. The applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. Being highly efficient, it is expected to economize on electric power usage, labor, and repair costs, and, most importantly, to reduce the number of defective chickens. In total, annual pre-tax savings of $170,000 will be realized if the new machine is installed. The company's marginal tax rate is 35% and the project cost of capital is 15%. a. What is the initial net cash flow if the new machine is purchased and the old one is replaced? Round your answer to the nearest dollar. Cash outflow, if any, should be indicated by a minus sign. b. Calculate the annual depreciation allowances for both machines, and compute the change in the annual depreciation expense if the replacement is made. Do not round intermediate calculations. Round your answers to the nearest dollar. Negative values, if any, should be indicated by a minus sign. Depreciation Allowance, New $ Year Depreciation Allowance, Old $ Change in Depreciation 1 $ 2 $ $ $ 3 $ $ $ 4 $ $ $ $ $ 5 $ the nearest dollar. Cash outflows, if c. What are the incremental net cash flows in Years 1 through 5? Do not round intermediate calculations. Round your answers any, should be indicated by a minus sign. CF1 $ $ CF2 CF3 $ CF4 $ CF5 $ d. Should the firm purchase the new machine? Support your answer. Do not round intermediate calculations. Round your answer to the nearest dollar. Negative value, if any, should be indicated by a minus sign. NPV: $ The firm -Select- purchase the new machine. e. In general, how would each of the following factors affect the investment decision, and how should each be treated? 1. The expected life of the existing machine decreases. If the expected life of the old machine decreases, the new machine will look -Select- as cash flows attributable to the new machine would -Select- 2. The cost of capital is not constant but is increasing as De Young adds more projects into its capital budget for the year. The -Select- capital cost should be used in the analysis
