Problem 12-16 Replacement analysis The Bigbee Bottling Company is contemplating
ID: 2734693 • Letter: P
Question
Problem 12-16
Replacement analysis
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 $575,000 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 $115,000 per year, using the straight-line method.
The new machine has a purchase price of $1,200,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $130,000. The applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. 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 of $200,000 will be realized if the new machine is installed. The company's marginal tax rate is 35%, and it has a 12% WACC.
What initial cash outlay is required for the new machine? Round your answer to the nearest dollar.
$
Should the firm purchase the new machine?
-Select-YesNoItem 22
Support your answer.
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.
Problem 12-16
Replacement analysis
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 $575,000 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 $115,000 per year, using the straight-line method.
The new machine has a purchase price of $1,200,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $130,000. The applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. 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 of $200,000 will be realized if the new machine is installed. The company's marginal tax rate is 35%, and it has a 12% WACC.
What initial cash outlay is required for the new machine? Round your answer to the nearest dollar.
$
What are the incremental net cash flows in Years 1 through 5? Round your answers to the nearest dollar. Year 1 Year 2 Year 3 Year 4 Year 5 $ $ $ $ $
Should the firm purchase the new machine?
-Select-YesNoItem 22
Support your answer.
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.
Explanation / Answer
dep rate value of machine dep on new machine 20% 1200000 240000 cost of machine 1200000 32% 1200000 384000 sale proceeds of old machine 265000 19% 1200000 228000 tax savings due to loss on sale of old machine 108500 108500 12% 1200000 144000 net cash outflow 826500 11% 1200000 132000 Year Depreciation Allowance, New Depreciation Allowance, Old Change in Depreciation 1 240000 115000 125000 2 384000 115000 269000 3 228000 115000 113000 4 144000 115000 29000 5 132000 115000 17000 Year annual savings dep after dep savings tax 35% after tax savings dep after tax before dep savings present value@12% present value of cash flow 1 200000 125000 75000 26250 48750 125000 173750 0.892857 155133.9 2 200000 269000 -69000 0 -69000 269000 200000 0.797194 159438.8 3 200000 113000 87000 30450 56550 113000 169550 0.71178 120682.3 4 200000 29000 171000 59850 111150 29000 140150 0.635518 89067.86 5 200000 17000 183000 64050 118950 17000 135950 0.567427 77141.68 130000 0.567427 73765.49 present value of cash flow 675230.1 cash outflow 826500 npv -151270 project should not be accepted as having negative npv 1- if the life of the machine decreases depreciation amount would be adjusted accordingly 2-if wacc increases new npv would be calculated @ new rate