Replacement Project Analysis

Replacement Project Analysis

BQC is considering replacing an old machine with a new, more sophisticated model for a project. The new machine’s purchase price is $380,000 and an additional $20,000 will be required to install it. It will be depreciated under MACRS yielding depreciation expenses of $80,000, $128,000, $76,000, $48,000, $48,000 in years 1 through 5, respectively, leaving a salvage value of $20,000 at the end of year 5. The old machine was purchased at a cost of $240,000 three years ago and has a current book value of $69,600. Its remaining depreciation expenses under MACRS are $28,800 in year 1, $28,800 in year 2, and $12,000 in year 3 at which point it will have a book value of $0 but 2 years of useful life remaining. The firm has found a buyer willing to pay $280,000 for the present machine and remove it at the buyer’s own expense. BQC expects that a $35,000 increase in current assets and an $18,000 increase in current liabilities will accompany the replacement.

Net operating cash flows (before tax) for the new machine are expected to be $220,000 per year for the 5 years of its useful life. With the present machine, net operating cash flows of $210,000, $190,000, $170,000, $150,000 and $130,000 are expected over the next five years respectively.

BQC estimates the liquidation value of the new machine at the end of its five-year useful life to be $50,000 after cleanup and removal costs. The old machine will be obsolete at the end of another 5 years and hence will have no salvage value. The $17,000 net working capital investment will be recovered at termination of the project.

BQC’s federal-plus-state tax rate remains at 40% and the replacement project is of slightly below-average risk. Because of the lower risk, the project’s cost of capital is only 11.5%.

You must decide whether to replace the machine or not and show the above calculations on excel

 
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