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;itwasbeingdepreciatedunderMACRSusinga5−yearrecoveryperiod.Theexistinggrinderisexpectedtohaveausablelifeof5moreyears.Thenewgrindercosts 105,000 and requires 5,000ininstallationcosts;ithasa5−yearusablelifeandwouldbedepreciatedunderMACRSusinga5−yearrecoveryperiod.Lombardcancurrentlyselltheexistinggrinderfor 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,inventoriesby 30,000, and accounts payable by 58,000.Attheendof5years,theexistinggrinderwouldhaveamarketvalueofzero;thenewgrinderwouldbesoldtonet 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.)