MAD Inc.is considering the replacement of an existing machine

QUESTION

QuestionMAD Inc.is considering the replacement of an existing machine. The new machine costs $1.2million and requires installation costs of $200,000. The existing machine can be sold currentlyfor $300,000 before taxes. It is 3 years old, cost $900,000 new, and has a $360,000 book valueand a remaining useful life of 5 years. This old machine was being depreciated using 5-yearsimplified straight-line depreciation to zero and therefore has the final 2years of depreciationremaining. If it is held until the end of 5 years, the old machine’s market value will be $0. Overits 5-year useful life, the new machine should reduce operating costs by $375,000 per year. Thenew machine will be depreciated using 5-year MACRS depreciation. The new machine can besold for $ 350,000 at the end of 5 years. An increased investment in working capital of $40,000will be needed to support operations if the new machine is acquired. Assume the firm hasadequate operating income against which to deduct any loss experienced on the sale of theexisting machine. The firm has a 10% cost of capital and is subject to a 40% tax rate.5 Years MACRS rates: 0.2, 0.32, 0.19. 0.12, 0.11, 0.061. Determine the initial cost for the proposed replacement.2. Determine the annual (non – terminal) operating cash flows for years 1 through 5 for theproposed replacement.3. Determine the terminal cash flow for the proposed replacement at the end of year 5.4. What is the net present value and internal rate of return for the proposed replacement?5. Make a recommendation to accept or reject the replacement proposal, and justify your answer.

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