Problem 3: A machine currently in use was originally purchased 2 years ago for $40,000. The machine is being depreciated under MACRS using a 5-year recovery period; it has 3 years of usable life remaining. The current machine can be sold today to net $42,000 after removal and cleanup costs. A new machine, using a 3-year MACRS recovery period, can be purchased at a price of $140,000. It requires $10,000 to install and has a 3-year usable life. If the new machine is acquired, the investment in accounts receivable will be expected to rise by $10,000, the inventory investment will increase by $25,000, and accounts payable will increase by $15,000. Earnings before depreciation, interest, and taxes are expected to be $70,000 for each of the next 3 years with the old machine and to be $120,000 in the first year and $130,000 in the second and third years with the new machine. At the end of 3 years, the market value of the old machine will equal zero, but the new machine could be sold to net $35,000 before taxes. The firm is subject to a 40% tax rate. Percentage by recovery year 5 ycars Recovery year 3 усаrs 7 усars 10 ycars 33% 20% 14% 10% 45 32 25 18 3. 15 19 18 14 12 12 12 12 7. 6. 6. 10 11 Totals 100% 100% 100% 100% a.Determine the initial investment associated with the proposed replacement decision. b. Calculate the incremental operating cash inflows for years 1 to 4 associated with the proposed replacement. (Note: Only depreciation cash flows must be considered in year 4.) c. Calculate the terminal cash flow associated with the proposed replacement decision. (Note: This is at the end of year 3.)

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
icon
Related questions
Question
Problem 3: A machine currently in use was originally purchased 2 years ago for $40,000. The machine is
being depreciated under MACRS using a 5-year recovery period; it has 3 years of usable life remaining.
The current machine can be sold today to net $42,000 after removal and cleanup costs. A new machine,
using a 3-year MACRS recovery period, can be purchased at a price of $140,000. It requires $10,000 to
install and has a 3-year usable life. If the new machine is acquired, the investment in accounts receivable
will be expected to rise by $10,000, the inventory investment will increase by $25,000, and accounts
payable will increase by $15,000. Earnings before depreciation, interest, and taxes are expected to be
$70,000 for each of the next 3 years with the old machine and to be $120,000 in the first year and
$130,000 in the second and third years with the new machine. At the end of 3 years, the market value of
the old machine will equal zero, but the new machine could be sold to net $35,000 before taxes. The
firm is subject to a 40% tax rate.
Percentage by recovery year
Recovery year
3 усаrs
5 ycars
7 усаrs
10 ycars
33%
20%
14%
10%
45
32
25
18
3.
15
19
18
14
4
12
12
12
12
9.
6.
6.
10
11
Totals
100%
100%
100%
100%
a.Determine the initial investment associated with the proposed replacement decision.
b. Calculate the incremental operating cash inflows for years 1 to 4 associated with the proposed
replacement. (Note: Only depreciation cash flows must be considered in year 4.)
c. Calculate the terminal cash flow associated with the proposed replacement decision. (Note: This is at
the end of year 3.)
d. Depict on a time line the relevant cash flows found in parts a, b, and c that are associated with the
proposed replacement decision, assuming that it is terminated at the end of year 3.
Transcribed Image Text:Problem 3: A machine currently in use was originally purchased 2 years ago for $40,000. The machine is being depreciated under MACRS using a 5-year recovery period; it has 3 years of usable life remaining. The current machine can be sold today to net $42,000 after removal and cleanup costs. A new machine, using a 3-year MACRS recovery period, can be purchased at a price of $140,000. It requires $10,000 to install and has a 3-year usable life. If the new machine is acquired, the investment in accounts receivable will be expected to rise by $10,000, the inventory investment will increase by $25,000, and accounts payable will increase by $15,000. Earnings before depreciation, interest, and taxes are expected to be $70,000 for each of the next 3 years with the old machine and to be $120,000 in the first year and $130,000 in the second and third years with the new machine. At the end of 3 years, the market value of the old machine will equal zero, but the new machine could be sold to net $35,000 before taxes. The firm is subject to a 40% tax rate. Percentage by recovery year Recovery year 3 усаrs 5 ycars 7 усаrs 10 ycars 33% 20% 14% 10% 45 32 25 18 3. 15 19 18 14 4 12 12 12 12 9. 6. 6. 10 11 Totals 100% 100% 100% 100% a.Determine the initial investment associated with the proposed replacement decision. b. Calculate the incremental operating cash inflows for years 1 to 4 associated with the proposed replacement. (Note: Only depreciation cash flows must be considered in year 4.) c. Calculate the terminal cash flow associated with the proposed replacement decision. (Note: This is at the end of year 3.) d. Depict on a time line the relevant cash flows found in parts a, b, and c that are associated with the proposed replacement decision, assuming that it is terminated at the end of year 3.
Expert Solution
trending now

Trending now

This is a popular solution!

steps

Step by step

Solved in 4 steps with 4 images

Blurred answer
Knowledge Booster
Asset replacement decision
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.
Similar questions
Recommended textbooks for you
Essentials Of Investments
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
FUNDAMENTALS OF CORPORATE FINANCE
FUNDAMENTALS OF CORPORATE FINANCE
Finance
ISBN:
9781260013962
Author:
BREALEY
Publisher:
RENT MCG
Financial Management: Theory & Practice
Financial Management: Theory & Practice
Finance
ISBN:
9781337909730
Author:
Brigham
Publisher:
Cengage
Foundations Of Finance
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education