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 $3,050,000. Its current bookvalue is $1,800,000. If not sold, the old machine will requiremaintenance costs of $710,000 at the end of the year for the nextfive years. Depreciation on the old machine is $360,000 per year.At the end of five years, it will have a salvage value of $155,000and a book value of $0. A replacement machine costs $4,650,000 nowand requires maintenance costs of $380,000 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 $745,000. Itwill be fully depreciated by the straight-line method. In fiveyears, a replacement machine will cost $3,650,000. The company willneed to purchase this machine regardless of what choice it makestoday. The corporate tax rate is 25 percent and the appropriatediscount rate is 7 percent. The company is assumed to earnsufficient revenues to generate tax shields from depreciation.
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Calculate the NPV for the new and old machines.

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3.7 Ratings (491 Votes)

NPV is the difference between present value of net cash inflows and present value of net cash outflows for an investment We are considering whether to replace an old machine by replacing it with a new machine or to continue its usage After 5 years in both the cases the company will need to purchase a replacement machine costing 3650000 regardless of the choice made by it As this cash flow will be the same in both decisions it will be ignored in our calculations as it does not effect the cash flows for the decision to be made First we shall calculate See Answer

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