Replacement Analysis DeYoung Entertainment Enterprises is considering replacing
ID: 2745451 • Letter: R
Question
Replacement Analysis
DeYoung Entertainment Enterprises is considering replacing the latex molding machine it uses to fabricate rubber chickens with a newer, more efficient model. The old machine has a book value of $800,000 and a remaining useful life of 5 years. The current machine would be worn out and worthless in 5 years, but DeYoung can sell it now to a Halloween mask manufacturer for $270,000. The old machine is being depreciated by $160,000 per year, using the straight-line method.
The new machine has a purchase price of $1,175,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $105,000. The applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. Being highly efficient, it is expected to economize on electric power usage, labor, and repair costs, and, most importantly, to reduce the number of defective chickens. In total, an annual savings of $255,000 will be realized if the new machine is installed. The company's marginal tax rate is 35%, and it has a 12% WACC.
A) What is the initial net cash flow if the new machine is purchased and the old one is replaced? Enter negative answers with minus sign. $____
B) Calculate the annual depreciation allowances for both machines, and compute the change in the annual depreciation expense if the replacement is made.
Year
Depreciation Allowance, New
Depreciation Allowance, Old
Changes in Depreciation
1
$
$
$
2
$
$
$
3
$
$
$
4
$
$
$
5
$
$
$
C) What are the incremental net cash flows in Years 1 through 5? Round your answers to the nearest dollar.
CF1
CF2
CF3
CF4
CF5
D) Should the firm purchase the new machine?
Yes or No
NPV $ ______??
Year
Depreciation Allowance, New
Depreciation Allowance, Old
Changes in Depreciation
1
$
$
$
2
$
$
$
3
$
$
$
4
$
$
$
5
$
$
$
Explanation / Answer
(D) yes FirmShould Purchase the new Machine as Incremental cash flow is positive
(a) (i)Cash Flows by selling Old machine 175500 (ii) Cash flows by purchasing new machine Year Dep Tax Saving on Dep Saving in cost Cash Flows Dicounted Fact @12% Present Value 0 -1175000 1 -1175000 1 235000 82250 255000 337250 0.8929 301116.1 2 376000 131600 255000 386600 0.7972 308197.5 3 225600 78960 255000 333960 0.7118 237712.7 4 135360 47376 255000 302376 0.6355 192159.9 5 135360 47376 255000 302376 0.5674 171568.1 6 67680 23688 23688 0.5066 12000.34 6 Salvage 68250 68250 0.5066 34575.45 82330.2 So net cash flows = 175500+82330.2 257830.20