Question 1

A conveying machine was purchased by ABC Company 5 years ago at a price of $7,000. The expected life of the machine at the time of purchase was 10 years, with an estimated salvage value of zero. Depreciation was calculated on a straight line basis. The present book value is $3,500 (cost of $7,000 less accumulated depreciation of $3,500)¹.

A new special purpose machine is being purchased at a price of $9,000. Shipping and installation fees are $1,000. This new machine is expected to last for 5 years. The estimated salvage value is $2,000 at the end of the 5 years life of the new machine. This new machine is expected to reduce operating costs from $9,000 to $3,000. Costs of operations are $500. The net working capital will be increased by $600 on replacement.

The present market value of the old machine is $1,000, which is below the $3,500 book value on the old machine. It is being proposed that on acquisition of the new machine the old one will be sold to another company given that the expected market value of the old machine at the end of the project life is zero. The tax rate of the company is 40% and the new machine falls into the 5-year MACRS class.

MACRS 5-Year Depreciation New Machine

Year	Depreciation Base	MACRS Depreciation	Annual Depreciation
1	$10,000	20%	$2,000
2	10,000	32%	3,200
3	10,000	19%	1,900
4	10,000	12%	1,200
5	10,000	12%	1,200
6	10,000	5%	500
			$10,000

¹Depreciation of Machine Using Straight Line Method

Year	1	2	3	4	5	6	7	8	9	10
Depreciation	700	700	700	700	700	700	700	700	700	700
Accumulated Depreciation	700	1,400	2,100	2,800	3,500	4,200	4,700	5,600	6,300	7,000

1. Compute the relevant cash flows for this replacement project.