ABC Gas industries is considering a replacement of an old petroleum refining machine (model 16) acquired 4 years ago with costs of:

Purchasing price                     450,000

Shipping & Handling costs    10,000

Installation cost                      15,000

The new model 107 will be acquired at costs of

Purchasing price                     750,000

Shipping & Handling costs    20,000

Installation cost                      30,000

The new model will result in cost savings of 50,000 annually during years 1 to 4, 20,000 annually in the next 5 years and 10,000 annually during the last 2 years. The old model could be sold at his fair market value $240,000. ABC Gas industries tax rate is 36% and cost of capital is 16%.

REQUIRED

Model 16 Book Value

Gain or loss on the sale of Model 16

Tax benefit or tax obligation on the sale

Cash flow from the sale of model 16

Initial investment (net investment) in acquisition of model 107

Incremental depreciation year 2 and year 6

Total net benefits or net cash flows year 3 and year 7

Net present value of the replacement decision

Is the replacement a good decision?