Problem: Stanforth Research is evaluating the purchase of a highly sensitive temperature measurement equipment (TME) device. The new device will replace an existing piece of equipment that was purchased two years ago for $60,000 and is being depreciated using a five-year recovery period under ACRS. This equipment has 5 years of useful life and 4 years of depreciation expense (Years 3,4,5,6) remaining. The new TME will cost $105,000 plus $3,000 to install and is expected to remain useful for 5 years. The projected profits before depreciation and taxes are shown for both pieces of equipment. The existing equipment can currently be sold for $25,000. The firm is subject to a 40% tax rate on both ordinary income and capital gains.
Profits before Depreciation and Taxes
Year Existing New
Equipment TME
1 $156,000 $175,000
2 160,000 175,000
3 160,000 180,000
4 165,000 180,000
5 $170,000 $185,000
a. Calculate the initial investment associated with the purchase of the new TME.
b. Calculate the incremental operating cash inflows associated with the replacement of the existing equipment. (Note: Be sure to consider the depreciation in Year 6.)