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Determining Relevant Cash Flow

Stanforth Research is evaluating the purchase of a highly sensitive temperature measurement equipment (TME) device. The new device will replace an existing piece of equipment that was purchased two years ago for $60,000 and is being depreciated using a five-year recovery period under ACRS. This equipment has 5 years of useful life and 4 years of depreciation expense (Years 3,4,5,6) remaining. The new TME will cost $105,000 plus $3,000 to install and is expected to remain useful for 5 years. The projected profits before depreciation and taxes are shown for both pieces of equipment. The existing equipment can currently be sold for $25,000. The firm is subject to a 40% tax rate on both ordinary income and capital gains.
Profits before Depreciation and Taxes

Year Existing
Equipment New
TME
1 $156,000 $175,000
2 160,000 175,000
3 160,000 180,000
4 165,000 180,000
5 $170,000 $185,000
a. Calculate the initial investment associated with the purchase of the new TME.
b. Calculate the incremental operating cash inflows associated with the replacement of the existing equipment. (Note: Be sure to consider the depreciation in Year 6.)

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Exercise 8.1: Integrative-Determining Relevant Cash Flow
Stanforth Research is evaluating the purchase of a highly sensitive temperature measurement equipment (TME) device. The new device will replace an existing piece of equipment that was purchased two years ago ...

Solution Summary

The solution calculates the initial investment associated with the purchase of the new equipment and the incremental operating cash inflows associated with the replacement of the existing equipment.

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