Relevant cash flows—No terminal value Central Laundry and Cleaners is considering replacing an existing piece of machinery with a more sophisticated machine. The old machine was purchased 3 years ago at a cost of $52,000, and this amount was being depreciated under MACRS using a 5-year recovery period. The machine has 5 years of usable life remaining. The new machine that is being considered costs $75,900 and requires $3,900in installation costs. The new machine would be depreciated under MACRS using a 5-year recovery period. The firm can currently sell the old machine for $54000 without incurring any removal or cleanup costs. The firm is subject to a tax rate of 40%. The revenues and expenses (excluding depreciation and interest) associated with the new and the old machines for the next 5 years are given in the table.
New machine Old machine
Year Revenue Expenses
(excluding depreciation and interest) Revenue Expenses
(excluding depreciation and interest)
1 $749,700 $720,500 $674,000 $660,800
2 749,700 720,500 676,000 660,800
3 749,700 720,500 680,000 660,800
4 749,700 720,500 678,000 660,800
5 749,700 720,500 674,000 660,800
(Table contains the applicable MACRS depreciation percentages.)
Note: The new machine will have no terminal value at the end of 5 years.
a. Calculate the initial investment associated with replacement of the old machine by the new one.
b. Determine the incremental operating cash inflows associated with the proposed replacement. (Note: Be sure to consider the depreciation in year 6.)
c. Depict on a time line the relevant cash flows found in parts (a) and (b)associated with the proposed replacement decision.