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A corporation has decided to replace an existing asset with a newer model. Three years ago, the existing asset originally cost $30,000 and was being

A corporation has decided to replace an existing asset with a newer model. Three years ago, the existing asset originally cost $30,000 and was being depreciated under MACRS using a threeyear recovery period. The existing asset can be sold for $2,000. The new asset will cost $75,000, requires $5,000 in installation costs and will also be depreciated under MACRS using a fiveyear recovery period. If the new asset is acquired, the investment in accounts receivable will be expected to rise by $25,000, the inventory investment will decrease by $5,000 and accruals will increase by $10,000. Earnings before depreciation, interest and taxes are given in the table for 5 years. Interest expenses are $20,000 for 5 years. If the assumed tax rate is 40 percent on ordinary income and capital gains, what is the initial investment of this project? Calculate the incremental cash flows of the project for two years.

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Earnings before Depreciation, Interest and Taxes Existing Asset New asset Year 1 $160,000 Year 1 $170,000 2 140,000 2 170,000 3 130,000 3 170,000 4 130,000 4 170,000 5 130,000 5 170,000 Year Depreciation Percentages using MACRS 3 years 5 years 1 33% Year 1 20% 2 45% 2 32% 3 15% 3 19% 4 7% 4 12% 5 12% 6 5% Earnings before Depreciation, Interest and Taxes Existing Asset New asset Year 1 $160,000 Year 1 $170,000 2 140,000 2 170,000 3 130,000 3 170,000 4 130,000 4 170,000 5 130,000 5 170,000 Year Depreciation Percentages using MACRS 3 years 5 years 1 33% Year 1 20% 2 45% 2 32% 3 15% 3 19% 4 7% 4 12% 5 12% 6 5%

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