Muthusamy Curry Mills (MCM) is considering the purchase of a new milling equipment to replace an existing one that has

Question

Muthusamy Curry Mills (MCM) is considering the purchase of a new milling equipment to replace an existing one that has a book value of $3,000 and can be sold for $1,500. The old machine is being depreciated on a straight-line basis and its estimated salvage value 3 years from now is zero. The new machine will reduce costs (before taxes) by $7,000 per year. It has a 3-year life; with an installed cost of $14,000; and it can be sold for an expected $2,000 at the end of the third year. The new machine would be depreciated over its 3-year life using the MACRS method. The applicable depreciation rates are as follows: Year 1: 33% Year 2: 45% Year 3: 15% Year 4: 7% Assume a 40% tax rate and a cost of capital of 16%. a. What is the initial investment associated with the replacement of the old milling equipment by the new one ? b. How much is the incremental operating cash flows associated with the proposed replacement in Year 1,2,3 c. How much is the terminal cash flow ? d. How much is the

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Part (a) Existing machine has a book value of $3,000 and can be sold for $1,500. Loss on sale, L = Book value - sale value = 3,000 - 1,500 = $ 1,500 Tax rate = T = 40% Tax credit = L x T = 1,500 x 40% = $ 600 Hence, post tax sale value = Sale value + tax credit = 1,500 + 600 = $ 2,100 Hence, the initial investment associated with the replacement of the old milling equipment by the new one = Cost of new machine - post tax sale value of old machine = 14,000 - 2,100 = $ 11,900 Part (b) Please see the table below. All financials are in $. Please see the second column to understand the mathematics. The last row colored in yellow contains your answer. Year, n Linkage 0 1 2 3 Installed cost A 14,000.00 Depreciation rate b 33% 45% 15% Cost saving C 7,000.00 7,000.00 7,000.00 [-] Depreciation D = A x b 4,620.00 6,300.00 2,100.00 EBIT E = C - D 2,380.00 700.00 4,900.00 [-] Taxes F = 40% x E 952.00 280.00 1,960.00 NOPAT G = E - F 1,428.00 420.00 2,940.00 Incremental Operating cash flows G + D 6,048.00 6,720.00 5,040.00 Part (c) Remaining book value at the end of year 3 = Undepreciated value = Installed cost x depreciation rate for year 4 = 14,000 x 7% = $ 980 Sale value = $ 2,000 Gain on sale = 2,000 - 980 = 1,020 Tax on gain = 40% x 1,020 = 408 Hence, post tax sale value of new machine = 2,000 - 408 = $ 1,592 Hence, the terminal cash flow = post tax sale value of new machine - post tax potential sale value of old machine = 1,592 - 0 = 1,592 Part (d) Please see the table below. All

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Muthusamy Curry Mills (MCM) is considering the purchase of a new milling equipment to replace an existing one that has a book value of $3,000 and can be sold for $1,500

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Year, n	Linkage	0	1	2	3
Installed cost	A	14,000.00
Depreciation rate	b		33%	45%	15%

Cost saving	C		7,000.00	7,000.00	7,000.00
[-] Depreciation	D = A x b		4,620.00	6,300.00	2,100.00
EBIT	E = C - D		2,380.00	700.00	4,900.00
[-] Taxes	F = 40% x E		952.00	280.00	1,960.00
NOPAT	G = E - F		1,428.00	420.00	2,940.00
Incremental Operating cash flows	G + D		6,048.00	6,720.00	5,040.00