The Bigbee Bottling Company is contemplating the replacement of one of its bottling machines with a newer and more efficient one. The old machine was purchased prior to the new tax legislation, 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 of 5 years, and an estimated salvage value of $145,000. The new machine is eligible for 100% bonus depreciation at the time of purchase. It 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 before taxes of $220,000 will be realized if the new machine is installed. The companys marginal tax rate is 25% and it has a 12% WACC.

1. What initial cash outlay is required for the new machine after bonus depreciation is considered?

2. Calculate the change in the annual depreciation expense if the replacement is made.

3. What are the incremental cash flows in Years 1 through 5?

4. Should the firm purchase the new machine? Support your answer.

5. In general, how would each of the following factors affect the investment decision, and how should each be treated?

   1. The expected life of the existing machine decreases.

   2. The WACC is not constant, but is increasing as Bigbee adds more projects into its capital budget for the year.