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.)

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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.