Depreciation and New Machine
Developing and Relevant Cash Flows For Clark Upholstery Company’s Machine Renewal or Replacement decision
Bo Humphries , chief financial officer of Clark upholstery company, expects the firm’s net operating profit after taxes for the next 5 years to be as shown in the following table.
Year Net operating profit after taxes
1 $100,000
2 150,000
3 200,000
4 250,000
5 320,000
Bo is beginning to develop the relevant cash flows needed to analyze whether to renew or replace Clark’s only depreciable asset, a machine that originally cost $30,000, has a current book value of zero, and can now be sold for $20,000. (note: because the firm’s only depreciable asset is fully depreciated –its book value is zero- its expected operating cash inflows equal its net operating profit after taxes.) He estimates that at the end of 5 years, the existing machine can be sold to net $2000 before taxes. Bo plans to use the following information to develop the relevant cash flows for each of the alternatives.
Alternative 2: Replace the existing machine with a new machine that costs $100,000 and requires installation costs of $10,000. The new machine would have a 5-year usable life and would be depreciated under MACRS using a 5-year recovery period. The firm’s projected revenues and expenses (excluding depreciation and interest), if it requires the machine, would be as follows:
Year Revenue Expenses
(Excl, depr, and int.)
1 $1,000,000 $764,500
2 1,175,000 839,800
3 1,130,000 914,900
4 1,425,000 989,900
5 1,550,000 998,900
The new machine would result in an increased
Bo Humphries , chief financial officer of Clark upholstery company, expects the firm’s net operating profit after taxes for the next 5 years to be as shown in the following table.
Year Net operating profit after taxes
1 $100,000
2 150,000
3 200,000
4 250,000
5 320,000
Bo is beginning to develop the relevant cash flows needed to analyze whether to renew or replace Clark’s only depreciable asset, a machine that originally cost $30,000, has a current book value of zero, and can now be sold for $20,000. (note: because the firm’s only depreciable asset is fully depreciated –its book value is zero- its expected operating cash inflows equal its net operating profit after taxes.) He estimates that at the end of 5 years, the existing machine can be sold to net $2000 before taxes. Bo plans to use the following information to develop the relevant cash flows for each of the alternatives.
Alternative 2: Replace the existing machine with a new machine that costs $100,000 and requires installation costs of $10,000. The new machine would have a 5-year usable life and would be depreciated under MACRS using a 5-year recovery period. The firm’s projected revenues and expenses (excluding depreciation and interest), if it requires the machine, would be as follows:
Year Revenue Expenses
(Excl, depr, and int.)
1 $1,000,000 $764,500
2 1,175,000 839,800
3 1,130,000 914,900
4 1,425,000 989,900
5 1,550,000 998,900
The new machine would result in an increased