The Minot Kit Aircraft Company of Minot, North Dakota, uses a plasma cutter to fabricate metal aircraft

Question:

The Minot Kit Aircraft Company of Minot, North Dakota, uses a plasma cutter to fabricate metal aircraft parts for its plane kits. The company currently is using a cutter that it purchased used four years ago that has an $80,000 book value and is being depreciated $20,000 per year over the next four years. If the old cutter were to be sold today, the company estimates that it would bring in an amount equal to the book value of the equipment.

The company is considering the purchase of a new automated plasma cutter that would cost $400,000 to install and that would be depreciated over the next four years toward a $40,000 salvage value using straight-line depreciation. The primary advantage of the new cutter is the fact that it is fully automated and can be run by one operator rather than the three employees currently required. The labor savings would be $100,000 per year. The firm faces a marginal tax rate of 30 percent.

a. What are the differential operating cash flow savings per year during Years 1 through 4 for the new plasma cutter?

b. What is the initial cash outlay required to replace the existing plasma cutter with the newer model?

c. Sketch a timeline for the replacement project cash flows for Years 0 through 5.

d. If the company requires a 15 percent discount rate for new investments, should the fleet be replaced?

Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important... Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal...