Integrative—Determining relevant cash flows Lombard Company is contemplating the purchase of a new high-speed widget grinder to replace the 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 is expected to 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 pays taxes at a rate of 40% on both ordinary income and capital gains. The estimated profits before depreciation and taxes over the 5 years for both the new and the existing grinder are shown in the following table. (Table 3.2 on page 100 contains the applicable MACRS depreciation percentages.)

TABLE 3.2
Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes
Â	Percentage by recovery yeara
Recovery year	3 years	5 years	7 years	10 years
1	33%	20%	14%	10%
2	45	32	25	18
3	15	19	18	14
4	7	12	12	12
5	Â	12	9	9
6	Â	5	9	8
7	Â	Â	9	7
8	Â	Â	4	6
9	Â	Â	Â	6
10	Â	Â	Â	6
11	___	___	___	4
Totals	100%	100%	100%	100%

 

Profits before depreciation and taxes
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

a. Calculate the initial investment associated with the replacement of the existing grinder by the new one. b. Determine the incremental operating cash inflows associated with the proposed grinder replacement. (Note: Be sure to consider the depreciation in year 6.)

c. Determine the terminal cash flow expected at the end of year 5 from the proposed grinder replacement. d. Depict on a time line the relevant cash flows associated with the proposed grinder replacement decision. Lombard Company is contemplating the purchase of a new high-speed widget grinder to replace the 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 is expected to 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 pays taxes at a rate of 40% on both ordinary income and capital gains. The estimated profits before depreciation and taxes over the 5 years for both the new and the existing grinder are shown in the following table. (Table 3.2 on page 100 contains the applicable MACRS depreciation percentages.)

TABLE 3.2
Rounded Depreciation Percentages by Recovery Year Using MACRS for First Four Property Classes
Â	Percentage by recovery yeara
Recovery year	3 years	5 years	7 years	10 years
1	33%	20%	14%	10%
2	45	32	25	18
3	15	19	18	14
4	7	12	12	12
5	Â	12	9	9
6	Â	5	9	8
7	Â	Â	9	7
8	Â	Â	4	6
9	Â	Â	Â	6
10	Â	Â	Â	6
11	___	___	___	4
Totals	100%	100%	100%	100%

 

Profits before depreciation and taxes
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

a. Calculate the initial investment associated with the replacement of the existing grinder by the new one. b. Determine the incremental operating cash inflows associated with the proposed grinder replacement. (Note: Be sure to consider the depreciation in year 6.)

c. Determine the terminal cash flow expected at the end of year 5 from the proposed grinder replacement. d. Depict on a time line the relevant cash flows associated with the proposed grinder replacement decision.