Problem 13-14 Replacement Analysis

DeYoung Entertainment Enterprises is considering replacing the latex molding machine it uses to fabricate rubber chickens with a newer, more efficient model. The old machine has a book value of $800,000 and a remaining useful life of 5 years. The current machine would be worn out and worthless in 5 years, but DeYoung can sell it now to a Halloween mask manufacturer for $270,000. The old machine is being depreciated by $160,000 per year, using the straight-line method.

The new machine has a purchase price of $1,160,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $105,000. The applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. Being highly efficient, it is expected to economize on electric power usage, labor, and repair costs, and, most importantly, to reduce the number of defective chickens. In total, an annual savings of $255,000 will be realized if the new machine is installed. The company's marginal tax rate is 35%, and it has a 13% WACC.

1. What is the initial net cash flow if the new machine is purchased and the old one is replaced? Enter negative answers with minus sign. $
6. Calculate the annual depreciation allowances for both machines, and compute the change in the annual depreciation expense if the replacement is made.

   Year	Depreciation Allowance, New	Depreciation Allowance, Old	Change in Depreciation
   1	$	$	$
   2	$	$	$
   3	$	$	$
   4	$	$	$
   5	$	$	$

8. What are the incremental net cash flows in Years 1 through 5? Round your answers to the nearest dollar.

   CF1	$
   CF2	$
   CF3	$
   CF4	$
   CF5	$

9. Support your answer. Round your answer to the nearest dollar. NPV: $

10. In general, how would each of the following factors affect the investment decision, and how should each be treated? (1) The expected life of the existing machine decreases. (2) The WACC is not constant but is increasing as DeYoung adds more projects into its capital budget for the year.