Example #2 Replacement Analysis The Orange Fizz Company is contemplating the replacement of one of its bottling machines with a newer and more efficient one. The old machine has a book value of $500,000 and a remaining a useful life of 5 years. It can be sold today for $200,000. The firm does not expect to realize any return from scrapping the old machine in 5 years. The old machine is being depreciated toward a zero salvage value, or by $100,000 per year, using the simplified straight-line method. The new machine has a purchase price of $1.2 million, an estimated useful life and MACRS l'ecovery period of 5 years At the end of 5 years, the company expects to sell the new machine for $175,000. It is expected to economize on electric power usage, labor, and repair costs, and also to reduce the number of defective bottles. In total, an annual savings of $275,000 will be realized if it is installed. The company is in the 40 percent federal-plus-state tax bracket, and it has a 10 percent cost of capital. A. What is the initial cash flow? B. What are the operating cash flows? C. What is the terminal cash flow? D. Should the firm purchase the new machine? Why or why not? MACRS Depreciation Schedule 6026 3-year (33% 45 (15 Ownership Year 1 2 3 4 5 6 7 8 9 10 11 Class of investment 75-year 7-year 20% 14% 32 25 19 17 12 13 11 9 6 9 10-year 10% 18 14 12 9 7 7 7 7 6 3 9 4