You are a financial analyst at the Humongous Project Company (HPC). Four years ago, HPC purchased a machine at an installed cost of $70,000; the machine is being depreciated using MACRS with a 5-year recovery period. The machine has six years of useful life remaining and could be sold today for $403,000 after removal and cleanup costs.

A new, more efficient machine can be purchased for $280,000. The new machine would cost $10,000 to install and would have a useful life of 6 years; it would be depreciated using a 5-year MACRS depreciation recovery schedule. At the end of the six years, it would have an estimated salvage value of $60,000.

Because of the increased output of the new machine, the firm’s sales would rise, with a corresponding increase in accounts receivable of $40,000, an increase in inventories of $25,000, and an increase in accounts payable of $35,000.

The following chart shows the expected revenues and operating costs for the new and old machine for each year.

New Machine

Old Machine

Year	Revenue	Operating Costs	Revenue	Operating Costs
1	$265,000	$105,000	$140,000	61,000
2	$275,000	$115,000	$144,000	62,000
3	$285,000	$125,000	$148,000	$63,000
4	$295,000	$135,000	$150,000	$64,000
5	$280,000	$140,000	$146,000	$62,000
6	$275,000	$145,000	$143,000	$60,000

HPC’s applicable tax rate is 21%. HPC’s weighted-average-cost-of-capital is 14%. HPC uses a 4-year payback period rule, along with NPV, PI, and IRR.

The MACRS 5-year property depreciation schedules are as follows:

Year	Recovery Percentage
1	20%
2	32%
3	19%
4	12%
5	12%
6	5%

1. 
   

Determine the initial investment associated with the proposed investment decision.

Calculate the incremental operating cash flows for years 1 through 6 associated with the proposed replacement.

Calculate the terminal cash flow associated with the proposed replacement decision.

Show the relevant cash flows on a timeline.

Compute the NPV, IRR, Profitability Index, and payback period for this project. Should HPC accept this replacement decision? Why or why not?