In-class Assignment 1 Accounting for Decision Making Fall 2021 Sept.

21, 2021
Name: __________________Roll #_________Sec: ______

Suppose that a company is considering the purchase of a new automotive-glass molding machine to
replace an old molding machine and that it needs to obtain cash-flow information to evaluate the
attractiveness of this project. The purchase price of the new machine is $18,500, and it will require an
additional $1,500 to install. The old machine, which has a remaining useful life of four years, can be
sold for its depreciated (tax) book value of $2,000. The old machine would have no salvage value if
held to the end of its useful life.

The new machine should cut labor and maintenance costs and should produce other cash savings
totaling $7,100 a year before taxes for the first year, increasing by 5% each year, for the next four
years, after which it will probably have a salvage value of $700. These savings represent the net
operating revenue savings to the firm if it replaces the old machine with the new one.

Suppose that the new machine being considered falls into the three-year property category for
MACRS depreciation: 33.33%, 44.45%, 14.81%, and 7.41%. Moreover, assume the following in
regards to the old machine: The original depreciable basis was $9,000; the machine fell into the three-
year property class; and the remaining depreciable life is two years.

As a result of the new machine, an additional investment in net operating working capital will be
needed, which will be 3% of the net operating revenue savings to the firm.

You are required to fill the table below to calculate the relevant cash flows for this replacement
project. Remember, you are interested in the incremental impact of the project; hence you are
concerned with the differences in the cash flows resulting from continuing to use the old mold versus
replacing it with a new one.

Intermediate 0 1 2 3 4
calculations
Net operating revenue 7,100 7,455 7,828 8,219
savings

Depreciation on new 6,666 8,890 2,962 1,482

machine

Remaining 1,333 667 0 0

Depreciation on old
machine

Incremental 5,333 8,223 2,962 1,482

depreciation

Net operating working 213 224 235 247 0

capital
 In-class Assignment 1 Accounting for Decision Making Fall 2021 Sept. 21, 2021
Name: __________________Roll #_________Sec: ______

Calculating the future incremental cash flows:

Cash flow forecast 0 1 2 3 4

Net change in operating 7,100 7,455 7,828 8,219
revenue
Less: Incremental (5,333) (8,223) (2,962) (1,482)
depreciation
Net change in income 1,767 (768) 4,866 6,737
before taxes
Net increase (decrease) in (707) 307 (1,946) (2,695)
taxes @40% tax rate
Net increase in profit after 1,060 (461) 2,919 4,042
taxes
Add back increase in 5,333 8,223 2,962 1,482
depreciation
Incremental net cash flows 6,393 7,762 5,881 5,524

Change in net operating (213) (11) (11) (12) 247

working capital

Cost of new machine (20,000)

Sale of old machine 2,000
Tax on gain on sale of old 0
machine
Final salvage value of new 700
machine
(Taxes)/tax savings due to (280)
sale or disposal of new
machine

NET CASH FLOWS OF 6,383 7,751 5,870 6,191

THE REPLACEMENT
PROJECT