Blue Creek Industrial Inc. is considering updating its production process. The managers are considering replacing a machine...

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Blue Creek Industrial Inc. is considering updating itsproduction process. The managers are considering replacing amachine which it purchased four years ago with an installed cost of$620,000. There are 2 years of depreciation remaining using theMACRS rates given below. The new machine, a BIOVAT 3000, will cost$900,000 and will require an additional $29,000 for delivery andinstallation. This new unit will also require training costs ofapproximately $11,000. The MACRS rates are 20%, 32%, 19%, 12%, 11%,and 6% for years 1 through 6 respectively, and the marginal taxrate is 34%. The old machine is expected to be sold forapproximately $320,000 today or $38,000 ten years from now.
If BCI purchases the new equipment, annual revenues are expected toincrease by about $47,000 per year, however, the expenses areexpected to decrease from $42,000 with the old equipment to $27,000with the new machine in the first year. Beyond that, the company’sexpenses are expected to be an additional $3,000 less per year.Since the new machine is expected to be more efficient, netoperating working capital (mainly due to required inventory) isexpected to fall by $4,000 at the outset of the project and remainat that new level through the duration of the project.
a) (8 points) Calculate the year 0 cash flow which would be usedfor capital budgeting purposes.
b) (8 points) Calculate the year 1 net cash flow which would beused for capital budgeting purposes.

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a)	Cost of the new machine, including installation cost		$ -9,29,000.00
	Sale value of old machine	$ 3,20,000.00
	Book value of old machine = 620000*17% =	$ 1,05,400.00
	Gain on sale	$ 2,14,600.00
	Tax on gain at 34%	$ 72,964.00
	After tax sales proceeds of old machine = 320000-72964 =		$ 2,47,036.00
	Net cost of the replacement		$ -6,81,964.00
	After tax trainng costs = 11000*(1-34%) =		$ -7,260.00
	Reduction in NWC		$ 4,000.00
	Year 0 cash flow		$ -6,85,224.00
b)	Increase in revenue	$ 47,000.00
	Decrease in expenses (42000-27000)	$ 15,000.00
	Incremental depreciation:
	New machine = 929000*20% =	$ 1,85,800.00
	Old machine = 620000*11% =	$ 68,200.00
	Incremental depreciation	$ 1,17,600.00
	Incremental NOI	$ -55,600.00
	Tax at 34%	$ -18,904.00
	Incremental NOPAT	$ -36,696.00
	Add: Depreciation	$ 1,17,600.00
	Year 1 net cash flow	$ 80,904.00

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Transcribed Image Text

Blue Creek Industrial Inc. is considering updating itsproduction process. The managers are considering replacing amachine which it purchased four years ago with an installed cost of$620,000. There are 2 years of depreciation remaining using theMACRS rates given below. The new machine, a BIOVAT 3000, will cost$900,000 and will require an additional $29,000 for delivery andinstallation. This new unit will also require training costs ofapproximately $11,000. The MACRS rates are 20%, 32%, 19%, 12%, 11%,and 6% for years 1 through 6 respectively, and the marginal taxrate is 34%. The old machine is expected to be sold forapproximately $320,000 today or $38,000 ten years from now. If BCI purchases the new equipment, annual revenues are expected toincrease by about $47,000 per year, however, the expenses areexpected to decrease from $42,000 with the old equipment to $27,000with the new machine in the first year. Beyond that, the company’sexpenses are expected to be an additional $3,000 less per year.Since the new machine is expected to be more efficient, netoperating working capital (mainly due to required inventory) isexpected to fall by $4,000 at the outset of the project and remainat that new level through the duration of the project.a) (8 points) Calculate the year 0 cash flow which would be usedfor capital budgeting purposes.b) (8 points) Calculate the year 1 net cash flow which would beused for capital budgeting purposes.