Question

Assume that it is January 1,2022 , and that the Mendoza Company is considering the replacement of a machine that has been used for the past 3 years in a special project for the company. This project is expected to continue for an additional 5 years (i.e., until the end of 2026). Mendoza will either keep the existing machine for another 5 years ( 8 years total) or replace the existing machine now with a new model that has a 5-year estimated life. Pertinent facts regarding this decision are as follows: *Note: These amounts are used for depreciation calculations. Assume further that Mendoza is subject to a 30% income tax, for both ordinary income and gains/losses associated with disposal of machinery, and that all cash flows occur at the end of the year, except for the initial investment. Assume that straight-line depreciation is used for tax purposes and that any tax associated with the disposal of machinery occurs at the same time as the related transaction. Required: 1. Determine relevant cash flows (after-tax) at the time of purchase of the new machine (i.e., time 0: January 1, 2022). 2. Determine the relevant (after-tax) cash inflow each year of project operation (i.e., at the end of each of years 1 through 5). 3. Determine the relevant (after-tax) cash inflow at the end of the project's life (i.e., at the project's disposal time, December 31,2026 ). 5. Determine the undiscounted net cash flow (after tax) for the new machine and determine whether, on this basis, the old machine should be replaced. (For all requirements, do not round intermediate calculations. round your answers to the nearest whole dollar amount.)

Answer 1

To determine whether the old machine should be replaced, we need to calculate the relevant cash flows at different time points, considering the income tax rate. By comparing the undiscounted net cash flow of keeping the existing machine versus replacing it with the new machine, we can make the decision.

Step-by-step explanation:

In order to determine the relevant cash flows, we need to consider the after-tax effects of both keeping the existing machine and purchasing the new machine.

1. Cash flows at time 0: For the existing machine, there are no cash flows since it has already been purchased. For the new machine, the initial cash outflow is the cost of the machine. We need to determine the after-tax cost by considering the income tax rate.
2. Cash inflows each year of project operation: For each year (1-5), we need to calculate the after-tax cash inflow based on the project's estimated revenue and expenses, considering the income tax rate.
3. Cash inflow at the end of the project's life: At the end of the project's life (December 31, 2026), we need to determine the after-tax cash inflow from selling the machine, considering the income tax rate.

Undiscounted net cash flow: If the undiscounted net cash flow of the new machine is higher, it would indicate that the old machine should be replaced.