Assignment
Bob's Ice Cream's manager is pro-active in replacing machinery before it fails and is currently determining the pros and cons of the decision. It is your job as assistant manager to research the price for a new industrial freezer and a new industrial ice cream mixer/machine and report back with the initial investment needed for each, the incremental operating cash flows for years 1-3 (illustrated by using the income statement format) and the terminal cash flow associated with the replacements. All calculations, graphs and spreadsheets must be shown for the initial investment, MACR depreciation calculations, operating cash flows for years 1-3, and terminal cash flow. Do you recommend replacing either machine, both machines, or neither? Explain why.
Additional information has been provided by the manager to help with your financial calculations.
The current freezer was purchased 4 years ago for $50,000 and is being depreciated under MACR using a 5 year recovery period. It is thought to have 3 years of remaining life. The new machine will be depreciated using MACR and is expected to have the same life span and recovery period.
The current mixer was purchased at the same time as the freezer for $30,000, is being depreciated under MACR using a 3 year recovery period, and has 2 years of remaining life.
Another ice cream vendor has offered to purchase both machines; the freezer would bring $25,000 and the mixer $15,000.
By purchasing the new machinery, the investment in accounts receivable will increase, as well as accounts payable. These amounts will be determined by the purchase price of each machine. Earnings before depreciation, interest, and taxes are expected to be $75,000 for each of the next 3 years if the old machines are used, and expected to be $100,000 the first year if with the new, larger equipment, and $125,000 each year thereafter, until sold. At the end of three years, the market value of the new machines is expected to be 50% of the purchase price, before taxes. Bob's Ice Cream's tax rate is 40%.