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.