Sub: Finance Topic: Capital budgeting
Calculations of the projects free cash flows.
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A firm is considering the purchase of a new machine to replace the one that is currently in use.
It has gathered the following information on each of these machines:
Current Machine: The machine currently in use was originally purchased 2 years ago for
$40,000. It is being depreciated under the modified accelerated cost recovery system (MACRS)
using a 5-year recovery period, and has 3 years of usable life remaining. The current machine
can be sold today to net $42,000 after removal and cleanup costs. However, in 3 years (at the
end of Year 3) the market value of the old machine will be zero. The firm’s earnings before
depreciation, interest and taxes (EBDIT) are expected to be $70,000 for each of the next 3 years
if the old machine is kept in use.
New Machine: The new machine can be purchased at a price of $140,000 and requires $10,000
to install. It has a 3-year usable life and will be depreciated under the MACRS using a 3-year
recovery period. If the new machine is acquired, the investment in accounts receivable will be
expected to rise by $10,000, the inventory investment will increase by $25,000, and accounts
payable will increase by $15,000. At the end of 3 years, the new machine could be sold to net
$35,000 before taxes. Earnings before depreciation, interest and taxes (EBDIT) are expected to
be as follows with the new machine: