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The Bigbee Bottling Company is contemplating the replacement of one of its bottling machines with a newer and more efficient one
The Bigbee Bottling Company is contemplating the replacement of one of its bottling machines with a newer and more efficient one. The old machine has a book value of $625,000 and a remaining useful life of 5 years. The firm does not expect to realize any return from scrapping the old machine in 5 years, but it can sell it now to another firm in the industry for $235,000. The old machine is being depreciated by $125,000 per year, using the straight-line method.
The new machine has a purchase price of $1,100,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $140,000. The applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. It is expected to economize on electric power usage, labor, and repair costs, as well as to reduce the number of defective bottles. In total, an annual savings of $220,000 will be realized if the new machine is installed. The company's marginal tax rate is 35%, and it has a 12% WACC.
- What initial cash outlay is required for the new machine? Round your answer to the nearest dollar. Negative amount should be indicated by a minus sign.
$ - Calculate the annual depreciation allowances for both machines and compute the change in the annual depreciation expense if the replacement is made. Round your answers to the nearest dollar.
Year Depreciation Allowance, New Depreciation Allowance, Old Change in Depreciation 1 $ $ $ 2 3 4 5 - What are the incremental net cash flows in Years 1 through 5? Round your answers to the nearest dollar.
Year 1 Year 2 Year 3 Year 4 Year 5 $ $ $ $ $ - Should the firm purchase the new machine?
-Select-YesNoItem 22
Support your answer. The input in the box below will not be graded, but may be reviewed and considered by your instructor. - In general, how would each of the following factors affect the investment decision, and how should each be treated?
1. The expected life of the existing machine decreases.The input in the box below will not be graded, but may be reviewed and considered by your instructor.
2. The WACC is not constant, but is increasing as Bigbee adds more projects into its capital budget for the year.The input in the box below will not be graded, but may be reviewed and considered by your instructor.
Expert Solution
a.) Calculation of Initial Net Cash Flow of the project
Initial Cash Flow = Purchase Price of New Machine - Sale Value of Old Machine - Tax on Sale of Old Machine
Tax on Sale of Old Machine = (Book Value - Sale Value) * Tax Rate
= (625,000 - 235000) * 35%
= 136500
Initial Cash Flow = Purchase Price of New Machine - Sale Value of Old Machine - Tax on Sale of Old Machine
= 1,100,000 - 235,000 - 136500
= -728500
(b.) Calculation of Change in Depreciation
| Year | Depreaciation New (Initial Cost * MACRS Rate) | Deprecaition on Old | Change in Depreacition |
| 1 | 220000 | 125000 | 95000 |
| 2 | 352000 | 125000 | 227000 |
| 3 | 209000 | 125000 | 84000 |
| 4 | 132000 | 125000 | 7000 |
| 5 | 121000 | 125000 | -4000 |
(c.) Calculation of Incremental Cash Flows :
Below is the Table showing Incremental Cash Flows
| Year | After Tax Cash Flow [Annual saving * (1 - Tax Rate) | Change in Depreacition * Tax Rate | Incremental Cash Flow |
| 1 | 143000 | 33250 | 176250 |
| 2 | 143000 | 79450 | 222450 |
| 3 | 143000 | 29400 | 172400 |
| 4 | 143000 | 2450 | 145450 |
| 5 | 143000 | -1400 | 141600+114100=255700 |
After Tax Salvage Value = Salvage Value - Tax on Gain on Sale
Tax on Gain Sale of New Machine = ( Sale Value - Book Value ) * Tax Rate
= [ 140000 - (1100000 * 6%) ] * 35%
= 25900
After Tax Salvage Value = 140000 - 25900
= 114100
(d.) Below is the table showing Net Present value :
| Year | Cash Inflows | PVF @ 12% | Present Value of Cash Inflow |
| 1 | 176250 | 0.892857143 | 157366.0714 |
| 2 | 222450 | 0.797193878 | 177335.7781 |
| 3 | 172400 | 0.711780248 | 122710.9147 |
| 4 | 145450 | 0.635518078 | 92436.1045 |
| 5 | 255700 | 0.567426856 | 145091.047 |
| Total Present Value of Cash Outflows | 694940 | ||
| Add: Present Value of Cash Inflow | 728500 | ||
| Net present Value | -33560 |
(e.) If the expected life of old machine decreases , the new machine will look better as cash flows attributable to the new machine would increase.
The higher cost of capital should be used
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