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You recently began working for Orange Fizz Company. Company management is contemplating the replacement of its existing, three-year old bottling machines that originally cost $2,400,000 with newer and more efficient ones. The old, existing machines were placed on the MACRS five-year class life depreciation schedule three years ago. Total operating costs for the old bottling machines are $1,100,000 per year and Orange Fizz will bottle 12 million bottles per year each year for the next seven years. The firm expects to realize a $100,000 return from salvaging the old machines in 7 years; however, the existing machine may be sold now to another firm in the industry for $400,000. It retained, the old machines would be operational for the next 7-years.

The new machines, if purchased, would cost $2,600,000 and would be placed on a MACRS five-year class life depreciation but will be kept in operation for the next 7 years. The machines would have an estimated salvage value of $270,000 in seven years. Total annual savings in operating costs of $570,000 will be realized if the new bottling machines are installed. The company is in the 40% tax bracket, and it has a 10% WACC.

Should the replacement be made? Use a relative (incremental) cash flow analysis similar to what we did in class and in your text and determine the NPV and IRR for the replacement project.

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