The old machine was purchased 2 yrs ago for $3 million and was being depreciated using MACRS5 year class (20%, 32%, 19.2%, 11.52%, 11.52% and 5.76%). The old machine can be sold for $1 million at this time. If the old machine is not replaced, it can be sold for $400,000 4years from now.
The replacement machine has a cost of $2 million, an estimated useful life of 4 years. This machine will be depreciated using straight line method to 0 salvage value. The replacement machine would permit an output expansion, so sales would rise by $1 million per year, even so , the new machine’s much greater efficiency would cause operating expense to decline by $250,000 per year. The new machine would require that inventories be increased by $1million, but accounts payable and accrued expenses would simultaneously increase by 500,000 and 200,000 respectively. The interest expense on debt component of the capital required for this project will be $250,000 annually. The new machine can be sold for $50,000 at the end of 4yrs to another company.
The company’s marginal federal-plus state tax rate is 40%, and its WACC I 12%. What is the initial investment CF0?
What is the project’s cash flow for the first year t=1,2,3,4 ?
Should it replace the old machine?