The Bigbee Bottling Company is contemplating the replacementof one of its bottling machines with a newer and more efficient one. The old machinehas a book value of $600,000 and a remaining useful life of 5 years. The firm does not expectto realize any return from scrapping the old machine in 5 years, but it can sell it now toanother firm in the industry for $265,000. The old machine is being depreciated by $120,000per year, using the straight-line method.The new machine has a purchase price of $1,175,000, an estimated useful life andMACRS class life of 5 years, and an estimated salvage value of $145,000. The applicabledepreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. It is expected to economize onelectric power usage, labor, and repair costs, as well as to reduce the number of defectivebottles. In total, an annual savings of $255,000 will be realized if the new machine isinstalled. The company’s marginal tax rate is 35% and it has a 12% WACC.a. What initial cash outlay is required for the new machine?b. Calculate the annual depreciation allowances for both machines and compute thechange in the annual depreciation expense if the replacement is made.c. What are the incremental cash flows in Years 1 through 5?d. Should the firm purchase the new machine? Support your answer. e. In general, how would each of the following factors affect the investment decision,and how should each be treated?1. The expected life of the existing machine decreases.2. The WACC is not constant, but is increasing as Bigbee adds more projects into itscapital budget for the year.
The Bigbee Bottling Company is contemplating the replacement
of one of its bottling machines with a newer and more efficient one. The old machine
has a book value of $600,000 and a remaining useful life of 5 years. The firm does not expect
to realize any return from scrapping the old machine in 5 years, but it can sell it now to
another firm in the industry for $265,000. The old machine is being
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 $145,000. The applicable
depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. It is expected to economize on
electric power usage, labor, and repair costs, as well as to reduce the number of defective
bottles. 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 initial cash outlay is required for the new machine?
b. Calculate the annual depreciation allowances for both machines and compute the
change in the annual depreciation expense if the replacement is made.
c. What are the incremental cash flows in Years 1 through 5?
d. Should the firm purchase the new machine? Support your answer.
e. In general, how would each of the following factors affect the investment decision,
and how should each be treated?
1. The expected life of the existing machine decreases.
2. The WACC is not constant, but is increasing as Bigbee adds more projects into its
capital budget for the year.
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