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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\$ 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\$ 105,000 and requires $5,000\$ 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\$ 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\$ 40,000, inventories by $30,000\$ 30,000, and accounts payable by $58,000\$ 58,000. At the end of 5 years, the existing grinder would have a market value of zero; the new grinder would be sold to net $29,000\$ 29,000 after removal and cleanup costs and before taxes. The firm is subject to a 40%40 \% tax rate. The estimated earnings before depreciation, interest, and taxes over the 5 years for both the new and the existing grinder are shown in the following table.

| Year |

 Earnings before  depreciation, interest, and taxes \begin{array}{l}\text { Earnings before } \\\text { depreciation, interest, and taxes }\end{array}

| | | :---: | :---: | :---: | | | New grinder | Existing grinder | | 1 | $43,000\$ 43,000 | $26,000\$ 26,000 | | 2 | 43,000 | 24,000 | | 3 | 43,000 | 22,000 | | 4 | 43,000 | 20,000 | | 5 | 43,000 | 18,000 |

Calculate the initial investment associated with the replacement of the existing grinder by the new one.

To replace the current grinder, Lombard Company is thinking about buying a new, high-speed widget grinder. The current grinder was acquired two years ago for an installed cost of $60,000, and MACRS was being used to depreciate it utilising a five-year recovery period. The current grinder is anticipated to have a further five years of useful life. It has a 5-year useable life and would be depreciated under MACRS utilising a 5-year recovery period. The new grinder costs$105,000 and requires $5,000 in installation costs. Currently, Lombard can sell the existing grinder for$70,000 without having to pay for removal or cleanup. Accounts receivable would rise by $40,000, inventories would rise by$30,000, and accounts payable would rise by $58,000 to accommodate the additional business brought on by the acquisition of the new grinder. The old grinder would have little market worth after five years, and the new grinder would be sold for more money after taxes and after clean-up expenses. The company must pay 40% in taxes. The following table displays the anticipated 5-year earnings before depreciation, interest, and taxes for both the new and the current grinder.

 Year  New grinder  Existing grinder 1$43,000$26,000243,00024,000343,00022,000443,00020,000543,00018,000\begin{array}{ccc} \text { Year } & \text { New grinder } & \text { Existing grinder } \\ \hline 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 \end{array}

Using this, determine the terminal cash flow expected at the end of year 5 from the proposed grinder replacement.

Question

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;itwasbeingdepreciatedunderMACRSusinga5yearrecoveryperiod.Theexistinggrinderisexpectedtohaveausablelifeof5moreyears.Thenewgrindercosts60,000; 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 5,000ininstallationcosts;ithasa5yearusablelifeandwouldbedepreciatedunderMACRSusinga5yearrecoveryperiod.Lombardcancurrentlyselltheexistinggrinderfor5,000 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,inventoriesby40,000, inventories by 30,000, and accounts payable by 58,000.Attheendof5years,theexistinggrinderwouldhaveamarketvalueofzero;thenewgrinderwouldbesoldtonet58,000. At the end of 5 years, the existing grinder would 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 is subject to a 40% tax rate. The estimated earnings before depreciation, interest, and taxes over the 5 years for both the new and the existing grinder are shown in the following table.

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

b. Determine the incremental operating cash flows associated with the proposed grinder replacement. (Note: Be sure to consider the depreciation in year 6.)

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In this problem, we will determine Lombard Company's incremental operating cashflows associated with the proposed grinder replacement.

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