10: Cash Flow and Capital Budgetinga Calculate the initial cash outflow associated with the replacement of the existing washer with
the new one.
b Determine the incremental cash flows associated with the proposed washer replacement.
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 washer
replacement.
d Depict on a time line the incremental cash flows associated with the proposed washer-
replacement decision.P10-12 PanPac Shipping is considering replacing an existing ship with one of two newer, more efficient
ones. The existing ship is three years old, cost $32 million, and is being depreciated under the
diminishing value method using a five-year recovery period. Although the existing ship has only
three years of effective life remaining under the diminishing value method for taxation purposes,
it has a remaining useable life of five years. Ship A, one of the two possible replacement ships,
costs $40 million to purchase and $8 million to outfit for service. It has a five-year useable life and
will be depreciated under the diminishing value method using a five-year recovery period. Ship
B costs $54 million to purchase and $6 million to outfit. It also has a five-year useable life and will
be depreciated under the diminishing value method using a five-year recovery period. Increased
investments in net working capital will accompany the decision to acquire ship A or ship B.
Purchase of ship A would result in a $4 million increase in net working capital; ship B would result
in a $6 million increase in net working capital. The projected profits before depreciation and
taxes for each alternative ship and the existing ship are given in the following table.
Profits before depreciation and taxes
Year Ship A Ship B Existing ship
1 $21,000,000 $22,000,000 $14,000,000
2 21,000,000 24,000,000 14,000,000
3 21,000,000 26,000,000 14,000,000
4 21,000,000 26,000,000 14,000,000
5 21,000,000 26,000,000 14,000,000The existing ship can currently be sold for $18 million and will not incur any removal or clean-up
costs. At the end of five years, the existing ship can be sold to net $1 million before taxes. Ships
A and B can be sold to net $12 million and $20 million before taxes, respectively, at the end of
the five-year period. The company is subject to a 30% tax rate on both ordinary income and
capital gains.
a Calculate the initial outlay associated with each alternative.
b Calculate the operating cash flows associated with each alternative. Be sure to consider the
depreciation in year 6.
c Calculate the terminal cash flow at the end of year 5, associated with each alternative.
d Depict on a time line the incremental cash flows associated with each alternative.
P10-13 The management of Cybuy is evaluating replacing their large mainframe computer with a
modern network system that requires much less office space. The network would cost $500,000
(including installation costs) and, because of efficiency gains, would generate $125,000 per
year in operating cash flows (accounting for taxes and depreciation) over the next five years.
The mainframe has a remaining book value of $50,000 and would be immediately donated to a
charity for the tax benefit. Cybuy’s cost of capital is 10% and the tax rate is 30%. On the basis of
NPV, should management install the network system?