FBR Corporation has just finished minor renovations on their office building at a cost of $150,000. FBR originally allocated only $100,000 for this renovation. A memo from accounting suggests that the $50,000 cost overrun should be charged to the next new project the company will implement.

As its next project, FBR Corp. is considering the acquisition of a new machine that would replace one of their old machines in use. The new machine costs $0.9 million (t=0), and it can be sold at the end of its expected 4-year operating life for $300,000. The new machine takes up more space and GEC will need to move maintenance and cleaning supplies that used to be stored next to the machine to a small storage room that could otherwise be sublet for $25,000 a year (at t=1 to t=4). The old machine was bought 8 years ago for $800,000 and can be sold for $300,000 today or for $150,000 in 4 years. FBR paid $25,000 for a study which indicates that the new machine will reduce manufacturing costs by $220,000 annually. Moreover, net working capital will be reduced by $150,000 when the new machine is installed, and will increase again by $150,000 at the end of the machine’s operating life. Both machines belong to asset class 43 with a CCA rate of 30%. FBR’s marginal tax rate is 40%, and it uses a discount rate (required rate of return, RRR) of 14% to evaluate projects of this nature.

What is the initial cash outlay (the total cash flow at t=0)?

What is the first year’s cash flow (excluding the CCA Tax Shield)?

What is the last year’s cash flow (excluding the CCA Tax Shield)?

What is the year 3 CCA?

What is the PV CCA Tax Shield?

What is the NPV of the replacement project?

Should FBR Corp. replace the old machine with the new one?