Fitz Chemical Corp. (VCC) is considering the replacement of equipment used to produce its top selling proprietary catalyst, ZN5. The following information is available: The new equipment would allow VCC to fully meet the expected 10% annual increase in demand for its ZN5 catalyst over the next five years. The existing equipment would allow for a maximum capacity of 2,500 metric tons per year (MTPY) of the ZN5 catalyst. The existing equipment is fully depreciated and has a salvage value of zero. The plant manager has assured Jen Smith, the COO of VCC, that the plant would be fully able of producing up to 2,500 MTPY of the ZN5 for the next five years if it were kept and not replaced. The invoice price of the new equipment is $2.74 million; shipping and installation would cost an additional $140,000. The new equipment would be depreciated over a five-year MACRS recovery period and is expected to have a salvage value of $215,000 five years from today. The new equipment has an operating capacity of 4,000 MTPY. Sales of the ZN5 catalyst were 2,250 MT last year. As stated above, these sales are forecast to increase at a rate of 10% per year for the next five years (if production capacity allowed). The greater efficiency of the new equipment is expected to decrease operating expenses (excluding depreciation) from 54% to 50% of dollar sales. Fixed costs are expected to remain at $80,000 in the first year of the project. VCC expects to sell all catalyst produced next year (year 1 for the project) at a price of $2,775 per MT, regardless of whether the equipment is replaced or not. Prices and costs are expected to increase at the expected inflation rate of 3% per year. No changes in net operating working capital, NOWC, are expected. Assume VCCs marginal tax rate is 35%.

1. Compute the net initial investment outlay at time 0.

a. Compute the incremental operating cash flows each year for years 1-3.

b. Compute the terminal cash flows for year 5.