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STC & Tweety, LLP own and operate a canary breeding farm. For the most recent year, STC & Tweety generated revenues of $250,000, incurred operating

STC & Tweety, LLP own and operate a canary breeding farm. For the most recent year, STC &

Tweety generated revenues of $250,000, incurred operating costs of $120,000, and had an after-tax net income of $77,000.

STC & Tweety are considering replacing their canary breeding barn. The current (old)

breeding barn has a book value of $60,000 and could be sold today for $45,000. Alternatively,

the current barn could be used for the next 3 years, after which if could be sold for

$3,000.

If STC & Tweety decide to keep using the old barn then they anticipate spending $10,000

to fix (repair) the barn at the end of the first year. These costs are considered a routine

maintenance expense and will not increase the barns book value.

A new canary barn would cost $180,000, but it would save STC & Tweety $70,000 in before-

tax operating costs for each of the next three years. Additionally, after the third year

STC & Tweety could sell the new barn to a local farmer for $5,000.

STC & Tweety depreciate all of their assets using straight-line depreciation and zero assumed

salvage value. Their required rate of return (cost of capital) is 10%, and their tax

rate is 30%.

Assume all operating cash flows occur at year end.

Required:

a. Define the status quo.

b. Define the alternative.

c. What is the incremental initial after-tax cash outflow associated with the alternative

you have defined? Be sure to include all relevant cash flows.

d. What is the alternatives incremental after-tax cash inflow for the end of year two?

e. Draw a timeline that shows all of the incremental cash flows associated with the alternative

you have defined.

f. Should STC & Tweety, LLP invest in the new barn?

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