(no excel)
Klingman’s LTD. is considering replacing one of its production machines with a new piece of equipment. The existing equipment was purchased 5 years ago for $70,000. At that time it was estimated to have a useful life of 10 years. The machine is being depreciated using the simplified straight-line method and has market value today is $30,000. Four full-time machine operators are required to operate the machine, and each is paid a $34,000 annual salary. The existing machine creates about $5,000 worth of defects per year, and costs $4,000 per year to maintain.
The proposed machine’s purchase price is $120,000. Klingman’s will need to spend about 10% of the purchase price for installation. If purchased, it will be depreciated using SSLD over its five year expected useful life. Though the firm does not expect revenues to increase with the new machine, the new version is more efficient and less labor intensive. As a result only two machine operators are required to run the equipment, the cost of defects would drop to $2,500 per year, and maintenance would be $6,000 annually. Klingman’s expects to sell the machine for $15,000 at the end this time. The firm’s marginal tax rate is 40% and the required return for this type of project is 15%. What are the following cash flows associated with this replacement?
a. Initial Cost associated with this project?
b. Annual after-tax cash flows associated with this project (OCFs), for years 1 through 4?
c. Terminal year cash flow in year 5?