Speedy Auto Wash is contemplating the purchase of a new high-speed washer to replace the existing washer. The existing washer was purchased two years ago at an installed cost of $120,000; it was being depreciated under MACRS using a five-year recovery period. The existing washer is expected to have a usable life of five more years. The new washer costs $210,000 and requires $10,000 in installation costs; it has a five-year usable life and would be depreciated under MACRS using a five-year recovery period.
The existing washer can currently be sold for $140,000, without incurring any removal or cleanup costs. To support the increased business resulting from purchase of the new washer, accounts receivable would increase by $80,000, inventories by $60,000, and accounts payable by $116,000.
At the end of five years, the existing washer is expected to have a market value of zero; the new washer would be sold to net $58,000 after removal and cleanup costs, and before taxes. The firm pays taxes at a rate of 40 percent on both ordinary income and capital gains. The estimated profits before depreciation and taxes over the five years for both the new and the existing washer are shown in the following table
|
Year
|
Profits Before Depreciation and Taxes
|
|
New Washer
|
Existing Washer
|
|
1
|
$86,000
|
$52,000
|
|
2
|
86,000
|
48,000
|
|
3
|
86,000
|
44,000
|
|
4
|
86,000
|
40,000
|
|
5
|
86,000
|
36,000
|
a. Calculate the initial cash outflow associated with the replacement of the existing washer with the new one.
b. Determine the incremental cash flows associated with the proposed washer replacement. Be sure to consider the depreciation in year 6.
c. Determine the terminal cash flow expected at the end of year 5 from the proposed washer replacement.
d. Depict on a time line the relevant cash flows associated with the proposed washer-replacement decision.