Should the replacement asset be purchased? That is, does it make economic (financial) sense for XYZ to replace the existing machine? Support your answer by clearly showing the tax basis of the replacement asset (if purchased and under the assumption that the existing asset would be sold outright rather than traded in) and the annual after-tax cash flows associated with both decision options. Remember to record appropriate depreciation expense under MACRS for the existing asset, assuming it is sold January 1, 2015. Recall that the pre-tax cash flow from the disposal of the existing asset is assumed to occur on January 1, 2015, while the tax savings due to depreciation deductions under MACRS, as well as tax-related effects of the disposal (if any), are assumed to be realized at the end of 2015. Base your recommendation on both an NPV analysis and a comparison of the IRR associated with each of the two investment alternatives (keep vs. replace). Comment on your comparative results. Round all calculations, including intermediate calculations, to whole numbers (i.e., to zero decimal points).

XYZ Company was formed in the United States seven years ago by Jim Smith, Marsha Chang, and Earl Watson, who together purchased a commercial machine shop that had been in business for more than 40 years but, at the time of the acquisition, was feeling pressure from a variety of new entrants into the markets in which the machine shop competed. Smith had a distinguished military career and felt he could use the skills he acquired in the military to help this business return to its previously highly profitable state. Smith currently serves as the president and CEO of the company. XYZ produces three primary product lines, all of which are made of brass and are water-related: flow controllers, valves, and pumps. Marsha Chang, a long-time friend of Smith and his family, and a practicing CPA (Certified Public Accountant) and CMA® (Certified Management Accountant), joined the company as its CFO shortly before the formation of XYZ. Earl Watson, a high school friend of Smith, had worked as the manufacturing supervisor at the company for the past 10 years and, at the request of Smith, decided to stay onboard after the formation of XYZ. Over the past several years, Watson had toyed with the idea of introducing more technologically up to-date equipment that, he thought, could help ameliorate the competitive position of the company. Recently, Chang instituted an activity-based costing (ABC) system and a “bare-bones” Enterprise Resource Planning (ERP) system that, among other things, helped the company assess customer profitability and price its products more competitively. A new marketing manager, Maria Sanchez, was hired last year to develop and implement an aggressive product-promotion plan.

Answer rating: 100% (QA)

No This is because if the replacement asset is purchased Pretax operating cash inflow are expected t... View the full answer