Reference no: EM132596554

Muthusamy Curry Mills (MCM) is considering the purchase of a new milling equipment to replace an existing one that has a book value of $3,000 and can be sold for $1,500. The old machine is being depreciated on a straight-line basis and its estimated salvage value 3 years from now is zero. The new machine will reduce costs (before taxes) by $7,000 per year. It has a 3-year life; with an installed cost of $14,000; and it can be sold for an expected $2,000 at the end of the third year. The new machine would be depreciated over its 3-year life using the MACRS method. The applicable depreciation rates are as follows:

Year 1: 33%

Year 2: 45%

Year 3: 15%

Year 4: 7%

Assume a 40% tax rate and a cost of capital of 16%.

a. What is the initial investment associated with the replacement of the old milling equipment by the new one ?

b. How much is the incremental operating cash flows associated with the proposed replacement in Year 1,2,3

c. How much is the terminal cash flow ?

d. How much is the NPV and IRR of the replacement project ?

f. Should MCM replace the old milling equipment with the new one?