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 years 3 year 33% Recovery year 7 year 10 years 20% 14% 10% 45 32 25 18 15 19 18 14 12 12 12 12 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.)
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 years 3 year 33% Recovery year 7 year 10 years 20% 14% 10% 45 32 25 18 15 19 18 14 12 12 12 12 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
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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
3 year
S years
20%
Recovery year
7 years
10 years
33%
14%
10%
45
32
25
18
15
19
18
14
12
12
12
12
10
11
Totals
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.
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