Question 04:

BBA Company is considering the purchase of a new high speed widget grinder to replace the existing grinder. The existing grinder was purchased five years ago for $60,000 and has been depreciated under 5-year property class of MACRS (Existing grinder don't have any book value). The new grinder costs $105,000 and requires $5,000 for insurance and carriage inward. The 5- Year MACRS depreciation system is applicable on the new grinder. The existing grinder can be sold for $70,000 now without any other expense. The new grinder would provide before tax and before depreciation revenues of $43,000 per year whereas working capital level will be increased by $90,000. The salvage value of new machine is zero and corporate tax rate on company income and capital gains is 35%.

Required:

1. Calculate after tax relevant initial, interim incremental and terminal cash flows.

2. Depict on a time-line the relevant cash flows associated with the replacement project.

3. Make a decision regarding the selection of the replacement project by using NPV and PI if discount rate is 12%