Developing Relevant Cash Flows for Clark Upholstery Company's Machine. Renewal or Replacement DecisionBo Humphries, chief financial officer of Clark Upholstery Company, expects the firm's net operating profit after taxes for the next 5 years to be as shown in the following table.

Year	1	2	3	4	5
Net operating profit after taxes	$100,000	$150,000	$200,000	$250,000	$320,000

Bo is beginning to develop the relevant cash flows needed to analyze whether to renew or replace Clark's only depreciable asset, a machine that originally cost

$30,000,

has a current book value of zero, and can now be sold for $20,000.

(Note: Because the firm's only depreciable asset is fully

depreciatedlong dashits

book value is

zeroits

expected operating cash inflows equal its net operating profit after taxes.) He estimates that at the end of

5 years, the existing machine can be sold to net $2,000

before taxes. Bo plans to use the following information to develop the relevant cash flows for each of the alternatives.Alternative 1 Renew the existing machine at a total depreciable cost of$90,000.

The renewed machine would have a

55-year

usable life and would be depreciated under MACRS using a

5-year

recovery period. Renewing the machine would result in the following projected revenues and expenses (excluding depreciation and interest):

Year	1	2	3	4	5
Revenue	$1,000,000	$1,175,000	$1,300,000	$1,425,000	$1,550,000
Expenses (Excl. depreciation and interest)	801,500	884,200	918,100	943,100	968,100

The renewed machine would result in an increased investment in net working capital of

$15,000.

At the end of 5 years, the machine could be sold to net

$8,000 before taxes.Alternative 2 Replace the existing machine with a new machine that costs

$100,000

and requires installation costs of

$10,000.

The new machine would have a

5-year

usable life and would be depreciated under MACRS using a

5-yearrecovery period. The firm's projected revenues and expenses (excluding depreciation andinterest), if it acquires the machine, would be as follows:

Year	1	2	3	4	5
Revenue	$1,000,000	$1,175,000	$1,300,000	$1,425,000	$1,550,000
Expenses (Excl. depreciation and interest)	764,500	839,800	914,900	989,900	998,900

The new machine would result in an increased investment in net working capital of

$22,000.

At the end of

5 years, the new machine could be sold to net $25,000

before taxes. The firm is subject to a

40%

tax rate. Assume a 9

percent discount rate. As noted, the company uses MACRS depreciation

Rounded_Depreciation_Percentages_by_Recovery_Year_Using_MACRS_for_

First_Four_Property_Classes * * * *

* 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%

* * * * *

To Do

a. Calculate the initial investment associated with each of Clark Upholstery's alternatives.

b. Calculate the incremental operating cash inflows associated with each of Clark's alternatives. (Note: Be sure to consider the depreciation in year 6.)

c. Calculate the terminal cash flow at the end of year5

associated with each of Clark's alternatives.d. Use your findings in parts

(a),

(b),

and

(c)

to depict on a time line the relevant cash flows associated with each of Clark Upholstery's alternatives.

e. Solely on the basis of your comparison of their relevant cash flows, which alternative appears to be better? Why?

*Round to the nearest dollar