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Capital Budgeting Cash Flows Question


Business XYZ is deciding whether or not to replace an existing asset. The proposed asset has a purchase cost of $40,000 and an installation cost of $6,000. The proposed asset will be depreciated over a six-year span using the straight-line depreciation approach. The new asset is expected to elevate sales by $18,000 and non-depreciation expenses by $2,500 annually over the life of the asset. Due to the increase in sales, the firm expects an increase in working capital of $2,000, and the business expects to be able to sell the asset for $5,000 at the end of its life. The existing asset was originally purchased two years ago for $24,000, has a remaining life of six years, and is being depreciated using the simple straight-line method. The expected salvage value at the end of the asset's life is $4,500; however, the current sale price of the existing asset is $19,000, and its current book value is $14,000. Business XYZ is in a 33% marginal tax bracket and has a required rate of return of 11%.

Calculate the value of this project. Should you replace the existing asset?

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This solution provides a detailed a computation of the given accounting problem.