QUESTIONThe Bigbee Bottling Company is contemplating the replacement of one of its bottling machines with a newer and more efficient one. The old machine has a book value of $600,000 and a remaining useful life of 5 years. The firm does not expect to realize any return from scrapping the old machine in 5 years, but it can sell it now to another firm in the industry for$265,000. The old machine is being depreciated by $120,000 per year, using the straight-line method. The new machine has a purchase price of$1,175,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $145,000. The applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. It is expected to economize on electric power usage, labor, and repair costs, as well as to reduce the number of defective bottles. In total, an annual savings of$255,000 will be realized if the new machine is installed. The company’s marginal tax rate is 35% and it has a 12% WACC. a. What initial cash outlay is required for the new machine? b. Calculate the annual depreciation allowances for both machines and compute the change in the annual depreciation expense if the replacement is made. c. What are the incremental cash flows in Years 1 through 5? d. Should the firm purchase the new machine? Support your answer. e. In general, how would each of the following factors affect the investment decision, and how should each be treated? 1. The expected life of the existing machine decreases. 2. The WACC is not constant, but is increasing as Bigbee adds more projects into its capital budget for the year. QUESTIONIn late 1980, the U.S. Commerce Department released new data showing inflation was 15%. At the time, the prime rate of interest was 21%, a record high. However, many investors expected the new Reagan administration to be more effective in controlling inflation than the Carter administration had been. Moreover, many observers believed that the extremely high interest rates and generally tight credit, which resulted from the Federal Reserve System’s attempts to curb the inflation rate, would lead to a recession, which, in turn, would lead to a decline in inflation and interest rates. Assume that, at the beginning of 1981, the expected inflation rate for 1981 was 13%; for 1982, 9%; for 1983, 7%; and for 1984 and thereafter, 6%. a. What was the average expected inflation rate over the 5-year period 1981–1985? (Use the arithmetic average.) b. Over the 5-year period, what average nominal interest rate would be expected to produce a 2% real risk-free return on 5-year Treasury securities? Assume MRP=0. c. Assuming a real risk-free rate of 2% and a maturity risk premium that equals $0.1 \times(t) \%$, where t is the number of years to maturity, estimate the interest rate in January 1981 on bonds that mature in 1, 2, 5, 10, and 20 years. Draw a yield curve based on these data. d. Describe the general economic conditions that could lead to an upward-sloping yield curve. e. If investors in early 1981 expected the inflation rate for every future year to be 10% (i.e., $\mathrm{I}_{\mathrm{t}}=\mathrm{I}_{\mathrm{t}+1}=10 \%$ for t=1 to $\infty)$, what would the yield curve have looked like? Consider all the factors that are likely to affect the curve. Does your answer here make you question the yield curve you drew in part c? 6th EditionMcGraw-Hill Education3,760 solutions

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