Chapter 12, Problem 21P

### Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

Chapter
Section

### Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

# REPLACEMENT ANALYSIS The Bigbee Bottling 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 \$600,000 and a remaining useful life of 5 years. The firm does not expect to realize any return from scrapping the old machine in 5 years, but it can sell it now to another firm in the industry for \$265,000. The old machine is being depreciated by \$120,000 per year, using the straight-line method.The new machine has a purchase price of \$1,175,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of \$145,000. The applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. It is expected to economize on electric power usage, labor, and repair costs, as well as to reduce the number of defective bottles. 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 12% WACC. a. What initial cash outlay is required for the new machine? b. Calculate the annual depreciation allowances for both machines and compute the change in the annual depreciation expense if the replacement is made. c. What are the incremental cash flows in Years 1 through 5? d. Should the firm purchase the new machine? Support your answer. e. 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 Bigbee adds more projects into its capital budget for the year.

a.

Summary Introduction

To Determine: The initial cash outlay needed for the new machine.

Introduction: The net present value is also termed as the discounted cash flow approach is a mainstream capital budget method that considers the time value of cash. It utilizes net present value of the investment as the base to accept or reject a projected investment in projects like buying of new machine, buying of stock or inventory etc.

Explanation

Determine the initial cash outlay required for the new machine

Using a excel spreadsheet, the initial cash outlay required for the new machine is determined as -\$792,750.

b.

Summary Introduction

To Determine: The yearly depreciation allowances for both the machines and the variations in annual depreciation expense.

c.

Summary Introduction

To Determine: The incremental cash flows from year 1 to 5.

d.

Summary Introduction

To Determine: Whether Company BB should purchase the new machine.

e1.

Summary Introduction

To Determine: The ways in which the expected life of the existing machine decreases affect the investment decision.

e2.

Summary Introduction

To Determine: The ways in which the inconsistent WACC affect the investment decision.

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