Suppose you need to decide whether to keep a machine or replace it with a new...

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Finance

Suppose you need to decide whether to keep a machine or replaceit with a new one:
Old machine: The old machine can operate for 5years with operating cost of $120,000 per year.
New machine: Replacing the old machine with anew one requires a capital cost of $250,000 in year zero (assumethat there is zero salvage value for old machine). The capital costis depreciable from year 0 to year 5 (over six years) based onMACRS 5-year life depreciation with the half year convention (tableA-1 at IRS). The new machine has a lower operating cost of $45,000per year for 5 years (from year 1 to year 5).
Assume both machines produce similar good with similar valuethat yields similar revenue.
Consider income tax of 35% and a discount rateof 10% annually. In present discounted valueterms, how much will you save by replacing the old machine with thenew machine?
(Note: What you are being asked to do here is to conductincremental NPV analysis on the new machine versus the old machine,NPV_{new machine - old machine}.)

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4.3 Ratings (796 Votes)

From below calculations we can see NPV of new machine is less ie 293220 hence basis incremental NPV analysis we should go with New Machine option Saving 2461 Old Machine Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 See Answer

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Transcribed Image Text

Suppose you need to decide whether to keep a machine or replaceit with a new one:Old machine: The old machine can operate for 5years with operating cost of $120,000 per year.New machine: Replacing the old machine with anew one requires a capital cost of $250,000 in year zero (assumethat there is zero salvage value for old machine). The capital costis depreciable from year 0 to year 5 (over six years) based onMACRS 5-year life depreciation with the half year convention (tableA-1 at IRS). The new machine has a lower operating cost of $45,000per year for 5 years (from year 1 to year 5).Assume both machines produce similar good with similar valuethat yields similar revenue.Consider income tax of 35% and a discount rateof 10% annually. In present discounted valueterms, how much will you save by replacing the old machine with thenew machine?(Note: What you are being asked to do here is to conductincremental NPV analysis on the new machine versus the old machine,NPVnew machine - old machine.)