Problem $2$

Kudo Manufacturing Inc. is considering a new project involving the acquisition of a new machine that would

replace an older machine currently in use. The new machine costs $$650,000($at $t=0)$ and can be sold at the end of its

expected $4-$year operating life for $$380,000($at $t=4).$ The old machine was bought $3$ years ago for $$500,000$ and can

be sold for $$220,000$ today or for $$120,000$ in $4$ years. Both, the old and the new machine belong to asset class $43$

with a CCA rate of $30\%($AII applies$).$ The vendor will charge $$25,000$ for the installation of the new machine and

the removal of the old machine, and this amount must be capitalized and added to the class $43$CCA pool.

Management believes that the company will have other class $43$ assets in four years when the equipment is sold.

The cost of operating the old machine is expected to be $$150,000$ next year $($at $t=1)$ with this cost increasing at $4\%$

per year over the next three years $($at $t=2,$dots,$4).$ Management paid $$30,000$ for a study that estimates that the cost of

operating the new machine will be $$50,000$ in its first year of operation $($at $t=1)$ and will increase over the next three

years at the same rate as the old machine. Since the new machine is more reliable, the plant will need to keep fewer

spare parts in stock. Management expects that inventory levels can be reduced by $$40,000($at $t=0)$ when the new

machine is installed $($note$,$ at the end of the project, this change in net working capital will be reversed, i$.$e$.,$

inventory levels will increase again by $$40,000$ at the $t=4).$ Kudo's marginal tax rate is $35\%,$ and its required rate of

return $($RRR$)$ is $10\%.$

a$)$ What is the initial cash outlay $($the total cash flow at $t=0)?$

b$)$ What is the first year's cash flow $($at $t=1$; excluding the CCA Tax Shield$)?$

c$)$ What is the last year's cash flow $($at $t=4$; excluding the CCA Tax Shield$)?$

d$)$ What is the year $1$ CCA? $($Make sure you use the Accelerated Investment Incentive rule$)$

e$)$ What is the year $3$CCA $?($Make sure you use the Accelerated Investment Incentive rule$)$

f$)$ What is the PV of CCA Tax Shields? $($Make sure you use the Accelerated Investment Incentive rule$)$

g$)$ What is the NPV of the replacement project?