Truth Dance Company, Inc., a manufacturer of dance and exercise apparel, is considering replacing an existing piece of equipment with a more sophisticated machine.
Existing Machine
Cost = $100,000
Purchased 2 years ago
Depreciation using MACRS over 5-year recovery schedule
Current market value = $105,000
Five year usable life remaining
Proposed Machine
Cost = $150,000
Installation = $20,000
Depreciation - the MACRS a 5-year recovery schedule will be used
Five year usable life expected
Earnings before Depreciation and Taxes
Existing Machine
Year
1 $160,000
2 $150,000
3 $140,000
4 $140,000
5 $140,000
Proposed Machine
1 $170,000
2 $170,000
3 $170,000
4 $170,000
5 $170,000
The firm pays 40% taxes on ordinary income and capital gains
Questions:
a. Calculate the book value of the existing asset being replaced.
b. Calculate the tax effect from the sale of the existing asset.
c. Calculate the initial investment required for the new asset.
d. Summarize the INCREMENTAL after-tax cash flow (relevant cash flows) for years t=0 through t=5. (You will need the total cash flows from each machine to answer this question).