Question 1. ABC Waste Disposal is looking at replacing the current incinerator with a new one. The current incinerator originally cost $500,000 four years ago. The original estimated useful life was 10 years. ABC was depreciating it using straight line depreciation with an assumption of no residual value. (While it would be fully depreciated after 6 more years it would still be operational for another 10 years from now.) A new incinerator would cost $800,000 plus installation costs of $200,000 and would last 10 years. It too would be depreciated straight line to a residual value of 0 (though vendors have estimated that it could be sold at that point in time for $150,000). The tax rate for the company is 30%. The current incinerator can be sold for $200,000. There would be no change in NWC. Determine the net cost of the new incinerator.
Question 2. The new incinerator would allow for more garbage to be burned so collection revenues would increase with the new incinerator. Also, the new incinerator would be more energy efficient so operating costs would decrease. Following are projections for revenues and expenses and other pertinent data assuming the current incinerator is kept and also assuming the new one is purchased:
Existing Incinerator New Incinerator
Revenue $2,000,000 $2,400,000
Operating Expenses 1,000,000 900,000
Depreciation Expense ? ?
Interest Expense 100,000 200,000
Assume Accounts Receivable will equal 10% of annual sales .
Using the data from this problem and problem 1 determine incremental cash flows for year 1, years 2-6 (they will not change for years 2- 6) and then for years 7-9 (cash flows will remain constant those 3 years) if the new incinerator is purchased. (Note that the reason cash flows are different in year 1 from years 2-6 is due to the increase in A/R in year 1 which does not recur. The reason cash flows are different in years 7-9 from 2-6 is due to the fact that the old machine would be fully depreciated after year 6. Finally, the reason the cash flows are different in year 10 from years 7-9 is due to the sale of the new machine at the end of year 10.)