IntegrativeDetermining relevant cash flows

Lombard Company is contemplating the purchase of a newhigh-speed widget grinder to replace the existing grinder. The existing grinder was purchased 2 years ago at an installed cost of $55,200; it was being depreciated straight-line for 5 years. The existing grinder is expected to have a usable life of 5 more years. The new grinder costs $107,700 and requires $4,800 in installationcosts; it has a 5-year usable life and would be depreciated on astraight-line basis. Lombard can currently sell the existing grinder for $70,500 without incurring any removal or cleanup costs. To support the increased business resulting from purchase of the new grinder, accounts receivable would increase by $40,000, inventories by $29,800, and accounts payable by $58,900. At the end of 5 years, the existing grinder would have a market value ofzero; the new grinder would be sold to net $28,300 after removal and cleanup costs and before taxes. The firm is subject a 40% tax rate. The estimated earnings before depreciation, interest, and taxes over the 5 years for both the new and the existing grinder are shown in the following table.

a. Calculate the initial investment associated with the replacement of the existing grinder by the new one.

b. Determine the incremental operating cash inflows associated with the proposed grinder replacement.

c. Determine the terminal cash flow expected at the end of year 5 from the proposed grinder replacement.

d. Depict on a time line the relevant cash flows associated with the proposed grinder replacement decision.

Earnings before depreciation, interest, and taxes:

Year New Grinder Old Grinder

1 43,600 25,200

2 43,600 23,200

3 43,600 21,200

4 43,600 19,200

5 43,600 17,200