Village Bakers is considering replacing an existing oven with a new, more advanced oven.
The old oven was purchased three years ago at a cost of $30,000, and this amount was being depreciated under MACRS using a 5-year recovery period. The oven has five years of usable life remaining. The old oven may currently be sold for $22,000 without incurring any removal or cleanup costs.
The new oven being considered costs $40,500, requires $1,500 in installation costs, and would be depreciated under MACRS using a 5-year recovery period.
Village Bakers pays tax at a rate of 40% on both ordinary income and capital gains. The revenues and expenses (excluding depreciation) associated with the new and the old ovens for the next five years are given in the following table.
NEW OVEN OLD OVEN YEAR Revenue Expenses (Excluding Depreciation) Revenue Expenses (Excluding Depreciation) 1 $310,000 $288,000 $270,000 $264,000 2 $310,000 $288,000 $270,000 $264,000 3 $310,000 $288,000 $270,000 $264,000 4 $310,000 $288,000 $270,000 $264,000 5 $310,000 $288,000 $270,000 $264,000
a. Calculate the initial cash outflow associated with replacement of the old oven by the new one. You may use the provided initial cash investment form. Show all work for any credit.
b. Determine the incremental operating cash flows associated with the proposed replacement decision for Years 5 and 6 ONLY. You do not need to show Years 1, 2, 3, or 4 for the replacement decision incremental operating cash flows. You may use the OCI Template form.