CAPITAL BUDGETING ASSIGNMENT
Clemente Cement Company is contemplating the purchase of a new mixer to replace its existing mixer. The original mixer was purchased two years ago at an installed cost of $60,000; it was being depreciated under MACRS using a five year recovery period (20%, 32%, 19%, 12%, 12% and 5%). The existing mixer is expected to have a usable life of 5 more years. The new mixer costs $105,000 and requires $5,000 in installation costs. It has a 5-year usable life and would be depreciated under MACRS using a five year recovery period (same as old mixer).
Clemente can currently sell the existing grinder for $ 70,000 without incurring any cleanup or removal costs. To support the increased business resulting from the purchase of a new mixer, accounts receivable would increase by $40,000, inventories by $30,000 and accounts payable by $58,000. At the end of five years, the existing mixer would have a market value of zero; the new mixer would be sold to net $29,000 after removal and clean up costs and before taxes. The company is subject to a 40% tax rate.
The estimated earnings before depreciation, interest and taxes over the five years for both the new and existing mixer are below:
|
YEAR
|
New Mixer
|
Existing Mixer
|
|
1
|
$43,000
|
$26,000
|
|
2
|
$43,000
|
$24,000
|
|
3
|
$43,000
|
$22,000
|
|
4
|
$43,000
|
$20,000
|
|
5
|
$43,000
|
$18,000
|
With the information provided, calculate:
1. The initial investment associated with replacement of the old machine with the new one.
2. The incremental operating cash flows associated with the proposed replacement (be sure to consider the depreciation in year 6)
3. The terminal cash flow expected at the end of year 5 from the proposed mixer replacement.