# Question

Atlantic Control Company (ACC) purchased a machine two years ago at a cost of $70,000. At that time, the machine’s expected economic life was six years and its salvage value at the end of its life was estimated to be $10,000. It is being depreciated using the straight line method so that its book value at the end of its six-year life is $10,000. In four years, however, the old machine will have a market value of $0.

A new machine can be purchased for $80,000, including shipping and installation costs. The new machine has an economic life estimated to be four years. MACRS depreciation will be used, and the machine will be depreciated over its 3-year class life rather than its four-year economic life. During its four-year life, the new machine will reduce cash operating expenses by $20,000 (excluding depreciation) per year. Sales are not expected to change. But the new machine will require net working capital to be increased by $4,000. At the end of its useful life, the machine is estimated to have a market value of $2,500. The old machine can be sold today for $20,000. The firm’s marginal tax rate is 40 percent, and the appropriate required rate of return is 10 percent.

a. If the new machine is purchased, what is the amount of the initial investment outlay at Year 0?

b. What supplemental operating cash flows will occur at the end of Years 1 through 4 as a result of replacing the old machine?

c. What is the terminal cash flow at the end of Year 4 if the new machine is purchased?

d. What is the NPV of this project? Should ACC replace the old machine?

A new machine can be purchased for $80,000, including shipping and installation costs. The new machine has an economic life estimated to be four years. MACRS depreciation will be used, and the machine will be depreciated over its 3-year class life rather than its four-year economic life. During its four-year life, the new machine will reduce cash operating expenses by $20,000 (excluding depreciation) per year. Sales are not expected to change. But the new machine will require net working capital to be increased by $4,000. At the end of its useful life, the machine is estimated to have a market value of $2,500. The old machine can be sold today for $20,000. The firm’s marginal tax rate is 40 percent, and the appropriate required rate of return is 10 percent.

a. If the new machine is purchased, what is the amount of the initial investment outlay at Year 0?

b. What supplemental operating cash flows will occur at the end of Years 1 through 4 as a result of replacing the old machine?

c. What is the terminal cash flow at the end of Year 4 if the new machine is purchased?

d. What is the NPV of this project? Should ACC replace the old machine?

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