Calligraphy Pens is deciding when to replace its old machine. The machine's current salvage value is...

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Calligraphy Pens is deciding when to replace its old machine.The machine's current salvage value is $2,700,000. Its current bookvalue is $1,625,000. If not sold, the old machine will requiremaintenance costs of $675,000 at the end of the year for the nextfive years. Depreciation on the old machine is $325,000 per year.At the end of five years, it will have a salvage value of $120,000and a book value of $0. A replacement machine costs $4,300,000 nowand requires maintenance costs of $345,000 at the end of each yearduring its economic life of five years. At the end of the fiveyears, the new machine will have a salvage value of $710,000. Itwill be fully depreciated by the straight-line method. In fiveyears, a replacement machine will cost $3,300,000. The company willneed to purchase this machine regardless of what choice it makestoday. The corporate tax rate is 23 percent and the appropriatediscount rate is 7 percent. The company is assumed to earnsufficient revenues to generate tax shields from depreciation.Calculate the NPV for the new and old machines. (Do not roundintermediate calculations and enter your answers in dollars, notmillions, rounded to 2 decimal places, e.g., 1,234,567.89.)

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4.1 Ratings (506 Votes)

1)	NPV OF OLD MACHINE:
a)	Initial outlay:
	Current sale value (opportunity cost)	$ 27,00,000
	Current book value	$ 16,25,000
	Gain if sold	$ 10,75,000
	Tax on gain at 23%	$ 2,47,250
	After tax salvage value = 2700000-247250 =	$ 24,52,750
b)	PV of after tax annual maintenance costs = 675000(1-23%)(1.07^5-1)/(0.07*1.07^5) =	$ 21,31,078
c)	PV of depreciation tax shield = 32500023%(1.07^5-1)/(0.07*1.07^5) =	$ 3,06,490
d)	PV of after tax salvage value at EOY 5 = 120000*(1-23%)/1.07^5 =	$ 65,880
	NPV of old machine = -2452750-2131075+306490+65880 =	$ -42,11,455
2)	NPV OF NEW MACHINE:
a)	Initial outlay	$ 43,00,000
b)	PV of after tax annual maintenance costs = 345000(1-23%)(1.07^5-1)/(0.07*1.07^5) =	$ 10,89,217
c)	PV of depreciation tax shield = 86000023%(1.07^5-1)/(0.07*1.07^5) =	$ 8,11,019
d)	PV of after tax salvage value at EOY 5 = 710000*(1-23%)/1.07^5 =	$ 3,89,790
	NPV of new machine = -4300000-1089217+811019+389790 =	$ -41,88,408

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Transcribed Image Text

Calligraphy Pens is deciding when to replace its old machine.The machine's current salvage value is $2,700,000. Its current bookvalue is $1,625,000. If not sold, the old machine will requiremaintenance costs of $675,000 at the end of the year for the nextfive years. Depreciation on the old machine is $325,000 per year.At the end of five years, it will have a salvage value of $120,000and a book value of $0. A replacement machine costs $4,300,000 nowand requires maintenance costs of $345,000 at the end of each yearduring its economic life of five years. At the end of the fiveyears, the new machine will have a salvage value of $710,000. Itwill be fully depreciated by the straight-line method. In fiveyears, a replacement machine will cost $3,300,000. The company willneed to purchase this machine regardless of what choice it makestoday. The corporate tax rate is 23 percent and the appropriatediscount rate is 7 percent. The company is assumed to earnsufficient revenues to generate tax shields from depreciation.Calculate the NPV for the new and old machines. (Do not roundintermediate calculations and enter your answers in dollars, notmillions, rounded to 2 decimal places, e.g., 1,234,567.89.)