Assumed to earn sufficient revenues to generate tax shields

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Reference no: EM131312328

Pilot Plus Pens is deciding when to replace its old machine. The machine's current salvage value is $2.2 million. Its current book value is $1.4 million. If not sold, the old machine will require maintenance costs of $845,000 at the end of the year for the next five years. Depreciation on the old machine is $280,000 per year. At the end of five years, it will have a salvage value of $120,000 and a book value of $0. A replacement machine costs $4.3 million now and requires maintenance costs of $330,000 at the end of each year during its economic life of five years. At the end of the five years, the new machine will have a salvage value of $800,000. It will be fully depreciated by the straight-line method. In five years a replacement machine will cost $3,200,000. Pilot will need to purchase this machine regardless of what choice it makes today. The corporate tax rate is 40 percent and the appropriate discount rate is 8 percent. The company is assumed to earn sufficient revenues to generate tax shields from depreciation.

a. Calculate the NPV for the new machine.

b. Calculate the NPV for the old machine.

c. Should Pilot Plus Pens replace the old machine now or at the end of five years?

Reference no: EM131312328

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