Answer:
a. Calculate the initial investment associated with the replacement of the existing grinder by the new one.
initial investment = cost of new grinder + cost of installing new grinder - after tax cost of selling old grinder + increase in net working capital
- cost of new grinder = $105,000
- cost of installing new grinder = $5,000
- after tax cost of selling old grinder = $70,000 - ($70,000 - {$60,000 x (1 - 52%)] x 40%} = $70,000 - $16,480 = $53,520
- increase in net working capital = $40,000 + $30,000 - $58,000 = $12,000
initial investment = $105,000 + $5,000 - $53,520 + $12,000 = $68,480
b. Determine the incremental operating cash inflows associated with the proposed grinder replacement. (Note: Be sure to consider the depreciation in year 6.)
cash flows new grinder:
- year 1 = [($43,000 - $22,000) x (1 - 40%)] + $22,000 = $34,600
- year 2 = [($43,000 - $35,200) x (1 - 40%)] + $35,200 = $39,880
- year 3 = [($43,000 - $21,120) x (1 - 40%)] + $21,120 = $34,248
- year 4 = [($43,000 - $12,672) x (1 - 40%)] + $12,672 = $30,868.80
- year 5 = [($43,000 - $12,672) x (1 - 40%)] + $12,672 + $18,000 (NWC) + $19,934.40 (after tax salvage value) = $68,803.20
cash flows old grinder:
- year 1 = [($26,000 - $11,520) x (1 - 40%)] + $11,520 = $20,208
- year 2 = [($24,000 - $6,912) x (1 - 40%)] + $6,912 = $15,964.80
- year 3 = [($22,000 - $6,912) x (1 - 40%)] + $6,912 = $15,964.80
- year 4 = [($20,000 - $3,456) x (1 - 40%)] + $3,456 = $13,382.40
- year 5 = $18,000 x (1 - 40%) = $10,800
incremental cash flows:
year 1 = $34,600 - $20,208 = $14,392
year 2 = $39,880 - $15,964.80 = $23,915.20
year 3 = $34,248 - $15,964.80 = $18,283.20
year 4 = $30,868.80 - $13,382.40 = $17,486.40
year 5 = $68,803.20 - $10,800 = $58,003.20
c. Determine the terminal cash flow expected at the end of year 5 from the proposed grinder replacement.
terminal cash flow = recovering net working capital + after tax salvage value = $18,000 + $19,934.40 = $37,934.40
d. Depict on a time line the relevant cash flows associated with the proposed grinder replacement decision.
year 0 = -$68,480
year 1 = $34,600
year 2 = $39,880
year 3 = $34,248
year 4 = $30,868.80
year 5 = $68,803.20
