Allison Corporation is considering the purchase of a replacement machine. The new machine is priced at $54,000. However, the vendor has offered a $14,000 trade-in allowance for the old machine. The old machine has a net book value of $10,000 and a tax basis of zero. The new machine will perform essentially the same function as the old machine, except that it will be able to produce 1,000 more units of product than the old machine each year. Each unit of product currently sells for $ 11. The variable cost of manufacturing the product is $4 a unit whether the new or the old machine is used, and variable marketing costs are $1 a unit. In addition to increased output, the new machine is expected to reduce maintenance costs by the following amounts:
Year Cash Savings Related to Maintenance
1 .............................................$1,500
2 ............................................. 1,200
3 ............................................. 900
4 ............................................. 600
5 ............................................. 300
For financial accounting purposes, the new machine is to be depreciated on a straight-line basis over a period of 7 years, with an expected salvage value of $6,000 (based on current period prices). For tax purposes, however, the machine will be depreciated under MACRS as 5-year-class property. The tax rate is 40%. The anticipated inflation rate is 10%. All cash inflows and outflows are expected to be affected equally by inflation.
Required:
(1) Compute the inflation-adjusted after-tax cash flows that will be generated by the project for each year and in total. (Use the MACRS rates provided in Exhibit 22-4 to compute tax depreciation, and round the price-level index to three decimal places.)
(2) Compute the amount by which total after-tax cash inflows exceed the initial investment.