Question
The Bigbee Bottling Company is contemplating the replacement of one of its bottling machines with a newer and more efficient one. The old machine has
The Bigbee Bottling Company is contemplating the replacement of one of its bottling machines with a newer and more efficient one. The old machine has a book value of $600,000 and a remaining useful life of 5 years. The firm does not expect to realize any return from scrapping the old machine in 5 years, but it can sell it now to another firm in the industry for $265,000. The old machine is being depreciated by $120,000 per year using the straight-line method.
The new machine has a purchase price of $1,175,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $145,000. The applicable depreciation rates are 20%,32%,19%,12%,11%, and 6%. The machine is expected to economize on electric power usage, labor, and repair costs as well as to reduce the number of defective bottles. In total, an annual savings of $255,000 will be realized if the new machine is installed. The company's marginal tax rate is 35%, and it has a 12% WACC.
a) What initial cash outlay is required for the new machine?
b) Calculate the annual depreciation allowances for both machines and compute the change
in the annual depreciation expense if the replacement is made.
c) What are the incremental net cash flows in Years 1 through 5?
d) Should the firm purchase the new machine? Support your answer.
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