1. Existing machine was purchased 2 years ago at a cost of $3,200. It is being depreciated straight line over its 8 year life. It can be sold now for $3,000 or used for 6 more years at which time it will be sold for an estimated $500. It provides revenue of $5,000 annually and cash operating costs of $2,000 annually. A replacement machine can be purchased now for $7,800. It would be used for 6 years, and depreciated straight line. It will result in additional sales revenue of $1,500 annually, but because of its increased efficiency it would reduce cash operating costs by $600 per year. The new machine would require additional inventories of $700, and accounts receivable would increase by $300. Its expected salvage value in 6 years is $2,000.

The tax rate is 40% and the required rate of return is 13%. Should the old machine be replaced?

a. Calculate the incremental cash flow at time 0 (ie the initial cost of this replacement project). [5marks]

b. Calculate the incremental annual operating cash flows that result from the new machine. [5marks]

c. Calculate the incremental terminal cash flow. [5marks]