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Miami Saddles, Inc. is considering replacing some capital equipment. The equipment has a three year useful life and the tax authority allows it to be

Miami Saddles, Inc. is considering replacing some capital equipment. The equipment has a three year useful life and the tax authority allows it to be depreciated straight line to zero residual value over three years. The purchase price of the equipment is $270,000 and the company believes the replacement will save it $115,000 in annual pre-tax operating costs, excluding depreciation expenses. Miami Saddles believes that it can sell the equipment to net $30,000 from a disposal company. The company tax rate is 21% and the cost of capital for investments of this type is 6%.

  • What is the annual incremental operating cash flow if the company invests in the replacement equipment?
  • Taking into account the initial investment, any additional terminal flows, and that no incremental working capital will be needed, what is the net present value of the replacement decision?
  • What is the equivalent annual saving?

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