ABC Inc. is planning to replace an existing assembly with a more modern version. The old equipment was purchased five years for $500,000 five years ago and depreciated to a zero-value over the five years. The new equipment costs $1,000,000 and will be depreciated using the straight-line method over its 5-year economic life. The salvage value at the end of the fifth year is expected to be $80,000. The new machine will reduce costs by $600,000. The old equipment can be sold for $40,000. They will also have to set aside net working capital of $20,000 in year 0.

a. If the cost of capital is 16% and the tax rate is 40%, should they replace the machine?

b. If they also estimate that additional net working capital will be $30,000 in year 1, $40,000 in year 2 and $50,000 in year 3, how will that affect your answer. All new working capital will be recaptured in year 5. A numerical answer is required.