The Balboa Bottling Company is thinking of replacing an existing bottling machin
ID: 2736252 • Letter: T
Question
The Balboa Bottling Company is thinking of replacing an existing bottling machine with a newer and more efficient one. The current machine has a book value of $600,000 and a remaining useful life of 5 years, with annual depreciation of $120,000 per year. The firm doesn’t expect that there will be any salvage value in 5 years, but another company in the industry has offered $250,000 for the machine now.
The new machine will cost $1.2 million and have a useful life of 5 years. The asset can be depreciated using the MACRS 5-yr schedule (20%, 32%, 19%, 12%, 11%, 6% respectively) and will have an estimated salvage value of $200,000 at the end of 5 years. By using the new machine, the firm will have cost savings of $275,000 per year. The marginal corporate tax rate is 30% and the WACC is 12.5%.
Please show with excel screenshot or pasting.
What is the cash flow at time 0 if the new machine is purchased and the old one is replaced?
What is the annual depreciation allowance for both machines?
Determine the incremental depreciation expense if the old machine is replaced.
What are the operating cash flows for years 1-5 if the old machine is replaced?
Should the firm buy the new machine? Support your answer.
Explanation / Answer
CASH FLOW AT TIME '0': cost of the new machine 1200000 sale value of the old machine -250000 tax shield on loss on sale of old machine (600000-250000)*0.3 -105000 -355000 845000 DEPRECIATION ALLOWANCE: OLD MACHINE (SLM) 120000 120000 120000 120000 120000 NEW MACHINE 240000 384000 228000 144000 132000 rate of depreciation % 20 32 19 12 11 INCREMENTAL DEPRECIATION EXPENSE 120000 264000 108000 24000 12000 if the old machine is replaced OPERATIONAL CASH FLOWS IF THE OLD MACHINE IS REPLACED: cost savings 275000 275000 275000 275000 275000 incremental depreciation 120000 264000 108000 24000 12000 net savings before tax 155000 11000 167000 251000 263000 tax at 30% 46500 3300 50100 75300 78900 net savings after tax 108500 7700 116900 175700 184100 add: depreciation 120000 264000 108000 24000 12000 Annual operational cash flows 228500 271700 224900 199700 196100 TERMINAL CASH FLOWS: salvage value 200000 lessL tax on gain on sale (30% on 200000 - 72000) 38400 Net cash flow on sale of machine 161600 NPV: Annual operational cash flows 228500 271700 224900 199700 196100 pvif at 12.5% (WACC) 0.8889 0.7901 0.7023 0.6243 0.5549 pv 203111 214677 157954 124672 108822 Cumulative PV of operating cash flows 809235 PV of terminal cash flow (161600*0.5549) 89677 PV of inflows 898912 Less: Initial investment 845000 NPV 53912 SUGGESTION: Yes, the firm should buy the new machine as the NPV is positive.
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