Existing machine was purchased 2 years ago at a cost of $3,200. It is being depreciated...

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Existing machine was purchased 2 years ago at a cost of $3,200.It is being depreciated straight line over its 8 year life. It canbe sold now for $3,000 or used for 6 more years at which time itwill be sold for an estimated $500. It provides revenue of $5,000annually and cash operating costs of $2,000 annually. A replacementmachine can be purchased now for $7,800. It would be used for 6years, and depreciated straight line. It will result in additionalsales revenue of $1,500 annually, but because of its increasedefficiency it would reduce cash operating costs by $600 per year.The new machine would require additional inventories of $700, andaccounts receivable would increase by $300. Its expected salvagevalue in 6 years is $2,000.
The tax rate is 40% and the required rate of return is 13%.Should the old machine be replaced?
a. Calculate the incremental cash flow at time 0 (ie the initialcost of this replacement project). [5marks]
b. Calculate the incremental annual operating cash flows thatresult from the new machine. [5marks]
c. Calculate the incremental terminal cash flow. [5marks]

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3.9 Ratings (614 Votes)

a Cost of the replacement machine 7800 Sale value of the old machine 3000 Book value of the old machine 2400 Gain on sale 600 Tax on gain at 40 240 After tax sale value 3000240 2760 See Answer

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