MBA 504 Assignment 4.3: Holliday Manufacturing
Integrative: Investment decision Holliday Manufacturing is considering the replacement of an existing machine. The new machine cost $1,200,000 and requires installation cost of $150,000. The existing machine can be sold currently for $185,000 before taxes.
It is 2 years old, cost $800,000 new, and has a $384,000 book value and 5 year recovery period, and therefore has the final 4 years of depreciation remaining. If it is held for is held for 5 more year, the machine’s market value at the end of year 5 will be $0. Over its 5year life, the new should reduce operating cost by $350,000 per year. The new machine depreciated under MACRS using a 5 year recovery period. The new machine can be sold for $200,000 net of removal and cleanup cost at the cost the end of 5 years. An increased investment in net working capital of $25,000 will be needed to support operation if the new machine is acquired. Assume that the firm has adequate operating income against which to deduct any loss experienced on the sale of the exiting machine. The firm had a 9% cost of capital and is subject to a 40% tax rate.
a. Develop the relevant cash flow needed to analyze the proposed replacement.
Initial investment:
Installed cost of new asset =
Cost of the new machine $1,200,000 Installation costs 150,000
Total cost of new machine $1,350,000
- After-tax proceeds from sale of old asset =
Proceeds from sale of existing machine (185,000)
- Tax on sale of existing machine* (79,600)
Total after-tax proceeds from sale (264,600)
+ Increase in net working capital 25,000
Initial investment $1,110,400 Book value = $384,000 $185,000 - $384,000 = $199,000 loss from sale of existing press $199,000