The Erley Equipment Company purchased a machine 5 years ago at a cost of $80,000

Question

The Erley Equipment Company purchased a machine 5 years ago at a cost of $80,000. The machine had an expected life of 10 years at the time of purchase, and it is being depreciated by the straight-line method by $8,000 per year. If the machine is not replaced, it can be sold for $15,000 at the end of its useful life.

A new machine can be purchased for $180,000, including installation costs. During its 5-year life, it will reduce cash operating expenses by $45,000 per year. Sales are not expected to change. At the end of its useful life, the machine is estimated to be worthless. MACRS depreciation will be used, and the machine will be depreciated over its 3-year class life rather than its 5-year economic life; so the applicable depreciation rates are 33%, 45%, 15%, and 7%. The old machine can be sold today for $55,000. The firm's tax rate is 35%. The appropriate WACC is 16%.

a. If the new machine is purchased, what is the amount of the initial cash flow at Year 0? Round your answer to the nearest dollar.

b. What are the incremental net cash flows that will occur at the end of Years 1 through 5? Round your answers to the nearest dollar

c. What is the NPV of this project? Round your answer to the nearest cent.

Explanation / Answer

Part (a) If new machine is purchased, the amount of initial cash flow at Year 0 will be: -

1. Cash outflow of $ 180,000 for new machine and

2. Sale value of old machine as Cash Inflow = $ 55,000

Part (b) Incremental net cash flows are

Part (c) NPV of the project

NPV = $ 48,388

Particulars Year 1 Year 2 Year 3 Year 4 Year 5 Inflow due to cost reduction (A) $ 45,000 $ 45,000 $ 45,000 $ 45,000 $ 45,000 Tax on sale of old Machine (B) $    5,250 $           -   $           -   $           -   $           -   Inflow due to depreciation on new machine (Depreciation * Tax %) ( C ) $ 20,790 $ 28,350 $    9,450 $    4,410 $           -   Cash outflow due to depreciation on old Machine (Depreciation*Tax%) (D) $    2,800 $    2,800 $    2,800 $    2,800 $    2,800 Incremental (A-B+C-D) $ 57,740 $ 70,550 $ 51,650 $ 46,610 $ 42,200

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.