The Bigbee Bottling Company is contemplating the replacementof one of its bottling machines with a newer and more efficientone. The old machine has a book value of $600,000 and aremaining useful life of 5 years. The firm does not expect torealize any return from scrapping the old machine in 5 years, butit can sell it now to another firm in the industry for$265,000. The old machine is being depreciated by $120,000 peryear using the straight-line method.
The new machine has a purchase price of $1,175,000, an estimateduseful life and MACRS class life of 5 years, and an estimatedsalvage value of $145,000. The applicable depreciation ratesare 20%, 32%, 19%, 12%, 11%, and 6%. The machine is expectedto economize on electric power usage, labor, and repair costs aswell as to reduce the number of defective bottles. In total,an annual savings of $255,000 will be realized if the new machineis installed. The company's marginal tax rate is 35%,and it has a 12% WACC.
a. What initial cashoutlay is required for the new machine?
b. Calculate the annualdepreciation allowances for both machines and compute the change inthe annual depreciation expense if the replacement is made.
c. What are the incrementalnet cash flows in Years 1 through 5?
d. Should the firm purchase thenew machine? Support your answer.