INTEGRATIVE EXAMPLE: THE REPLACEMENT OF FACILITIES AT THE HIRSHLEIFER COMPANY The management of the Hirshleifer Company is evaluating the replacement of its existing manufacturing equipment with new equipment. The old equipment cost $200,000 five years ago, currently has a tax basis of $100,000, and has been depreciated on the straight-line basis over a 10-year life, with no salvage value. If Hirshleifer keeps the old equipment, it is expected to last another five years, at which time the 10-year-old equipment is expected to be sold for $10,000. The old equipment could be sold today for $120,000.

The Problem

The new equipment costs $300,000 and is expected to have a useful life of five years. The new equipment will be depreciated for tax purposes, using MACRS and a 5-year classified life. At the end of its useful life, management expects to sell the new equipment for $100,000. Meanwhile, the new equipment is expected to reduce production costs by $60,000 each year. In addition, since it is more efficient, Hirshleifer can reduce its raw material and work-in-process inventories. Hirshleifer expects to reduce its inventory by $10,000 as soon as the new equipment is placed in service.

The income of Hirshleifer is taxed at a rate of 35%. There are no tax credits available for this equipment. What cash flows would result for each of the five years from this replacement?