The KRAFT Corporation is considering replacing one of its machines with a new, more efficient machine. The old machine was bought at $200,000 four years ago and can currently be sold for $120,000. The old machine is being depreciated on a simplified straight-line basis down to a salvage value of $10,000 in the next 5 years. The replacement machine would cost $350,000, and have an expected life of 5 years, after which it could be sold for $50,000. Because of reductions in defects and material savings, the new machine would produce cash benefits of $100,000 per year before depreciation and taxes. The replacement would have an initial increase in account receivables of $30,000 and decrease inventory by $20,000 each year over the next 4 years, all of which would be recovered at the end of year 5. Assume simplified straight-line depreciation, a 34 percent marginal tax rate, and a required rate of return of 15 percent.
- What is the initial outlay associated with this project?
- What are the operating cash flows associated with this project?
- What is the terminal cash flow in year 10?
- Should the old machine be replaced?