Reference no: EM131577865
The McEnally Toy Corporation currently uses an injection molding machine that was purchased 2 years ago for $8,000. This machine is being depreciated on a straight line basis, and it has 4 years of remaining depreciable life and 6 years of remaining useful life. The estimated market value for the machine at the end of its useful life is $0. Richard McEnally is confident, however, that the machine could be sold today for $4,000.
The firm is considering a replacement machine that will cost of $8,000, last (and be depreciated over) 6 years, and have a market value of $800 at the end of its useful life. The replacement machine would permit an output expansion, so sales will be $1,000 higher (than with the old machine) each year for six years. In addition, due to the proposed machine's much greater efficiency, operating expenses will be $1,500 less (than with the old machine) in each year.
The new machine would require that inventories be increased from today's level of $40,000 to $45,000 at the end of year 1, $50,000 at the end of year 2, $52,000 at the end of years 3-5, and back down to $40,000 at the end of year 6.
The firm's marginal federal-plus-state tax rate is 40 percent, and its cost of capital is 15 percent. Should McEnally replace the old machine? Provide a numerical solution.