Reference no: EM132498373
Integrative: Determining net cash flows.
Lombard Company is contemplating the purchase of a new high-speed widget grinder to replace existing grinder. The existing grinder was purchased 2 years ago at an installed cost of $60,000; it was being depreciated under MACRS, using a 5-year recovery period. The existing grinder is expected to have a usable life of 5 more years. The new grinder costs $105,000 and requires $5,000 in installation costs; it has a 5-year usable life and would be depreciated under MACRS, using a 5-year recovery period. Lombard can currently sell the existing grinder for $70,000 without incurring any removal or cleanup costs. To support the increased business resulting from purchase of the new grinder, accounts receivable would increase by $40,000, inventories by $30,000, and accounts payable by $58,000. At the end of 5 years, the existing grinder would have a market value of zero; the new grinder would be sold to net $29,000 after removal and cleanup costs and before taxes. The firm is subject to 40% tax rate. The estimated earnings before interest, taxes, depreciation, and amortization over the 5 years for both the new and the existing grinder are shown in the following table.
Earnings before interest, taxes, depreciation and amortization
Year New Grinder Existing Grinder
1 $43,000 $26,000
2 $43,000 $24,000
3 $43,000 $22,000
4 $43,000 $20,000
5 $43,000 $18,000
Question a. Calculate the initial investment associated with the replacement of the existing grinder by the new one.
Question b. Determine the operating cash flows associated with the proposed grinder replacement. (Note: Be sure to consider the depreciation in year 6.)
Question c. Determine the terminal cash flow expected at the end of year 5 from the proposed grinder replacement.
Question d. Depict on a timeline the net cash flows associated with the proposed grinder replacement decision.