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 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. (See Table 4.2 on page 112 for the applicable

depreciation percentages.)

a. Calculate the initial investment associated with the replacement of the existing

grinder by the new one.

b. Determine the incremental operating cash flows 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.