Exercise Replacement Decision

Atlantic Drydock is considering replacing an existing hoist with one of two newer,
more efficient pieces of equipment. The existing hoist is 3 years old, cost $32,000,
and is being depreciated under straight-line method for 5-years. Although the
existing hoist has only 2 years (years 4 and 5) of depreciation remaining, it has a
remaining usable life of 5 years. Hoist A, one of the two possible replacement hoists,
costs $40,000 to purchase and $8,000 to install. On the other hand, Hoist B costs
$54,000 to purchase and $6,000 to install. Both have a 5-year usable life and will be
depreciated using the straight-line method.

Increased investments in net working capital will accompany the decision to acquire
hoist A or hoist B. Purchase of hoist A would result in a $4,000 increase in net
working capital; hoist B would result in a $6,000 increase in net working capital.
The projected earnings before depreciation, interest, and taxes with each alternative
hoist and the existing hoist are given in the following table.



The existing hoist can currently be sold for $18,000 and will not incur any removal
or cleanup costs. At the end of 5 years, the existing hoist can be sold to net $1,000
before taxes. Hoists A and B can be sold to net $12,000 and $20,000 before taxes,
respectively, at the end of the 5-year period. The firm is subject to a 40% tax rate.

Required:
a. Calculate the initial investment associated with each alternative.

b. Calculate the incremental operating cash inflows associated with each
alternative.

c. Calculate the terminal cash flow at the end of year 5 associated with each
alternative.

d. Depict on a time line the relevant cash flows associated with each alternative.