Reference no: EM132761272
Question: Speedy Auto Wash Ltd. is contemplating the purchase of a new high-speed washer to replace the existing washer. The existing washer was purchased two years ago at an installed cost of $120,000; it was being depreciated using the straight line method. The existing washer is expected to have a useful life of five more years. The new washer costs $210,000 and requires $10,000 in installation costs; it has a 5-year usable life and would be depreciated using the straight line method. The existing washer can be sold for $140,000 without incurring any removal or cleanup costs. To support the increased business resulting from purchase of the new washer, accounts receivable would be increased by $80,000, inventories by $60,000, and accounts payable by $116,000. At the end of five years, the existing washer is expected to have a market value of zero; the new washer would be sold at net $58,000 after removal and cleanup costs and before taxes. The firm pays taxes at a rate of 40 percent on both ordinary income and capital gains. The estimated profits before depreciation and taxes over the five years for both the new and the existing washer are shown in the following table: Profits before Depreciation and Taxes Year New Washer Existing Washer 1 $86,000 $52,000 2 $86,000 $52,000 3 $86,000 $52,000 4 $86,000 $52,000 5 $86,000 $52,000 The company uses the risk adjusted discount rate (RADR) to discount the project's cash flows. Classification by expenditure Risk Category RADR % Replacement 10 Expansion 12 New Products 15
Required: 1. Calculate the initial cash outflow associated with the replacement of the existing washer with the new one.
2. Determine the terminal cash flow expected at the end of year 5 from the proposed washer replacement.
3. Determine the incremental cash flows associated with the proposed washer replacement.
4. Calculate the net present value and advise whether the existing washer should be changed.