Reference no: EM13878351

Equipment Replacement, MACRS VacuTech is a high-technology company that manufactures sophisticated instruments for testing microcircuits. Each instrument sells for $3,500 and costs $2,450 to manufacture. An essential component of the company's manufacturing process is a sealed vacuum chamber where the interior approaches a pure vacuum. The technology of the vacuum pumps that the firm uses to prepare its chamber for sealing has been changing rapidly. On June 1, 2009, VacuTech bought the latest in electronic high-speed vacuum pumps that can evacuate in only six hours a chamber for sealing. The company paid $400,000 for the pump. Recently, the pump's manufacturer approached VacuTech with a new pump that would reduce the evacuation time to two hours.

VacuTech's management is considering the purchase of this new pump and has asked Doreen Harris, the company controller, to evaluate the financial impact of replacing it with the new model. Doreen has gathered the following information prior to preparing her analysis:

• The new pump could be installed and placed in service on January 1, 2013. The pump's cost is $608,000; installing, testing, and debugging it will cost $12,000. The pump would be assigned to the three-year class for depreciation under the Modified Accelerated Cost Recovery System (MACRS) and is expected to have an $80,000 salvage value when it is sold at the end of four years. Depreciation on the equipment would be recognized starting in 2013, and MACRS rates (rounded) would be as follows:

Year 1      33%
Year 2      45
Year 3      15
Year 4      7

• The current pump is being depreciated under MACRS and will be fully depreciated by the time the new pump is placed in service. If the firm purchases the new pump, it will sell the current pump for $50,000.

• At the current rate of production, the new pump's greater efficiency will result in annual pretax cash savings of $125,000.

• VacuTech is able to sell all testing instruments that it can produce. Because of the new pump's increased speed, output is expected to increase by 30 units in 2013, 50 units in both 2014 and 2015, and 70 units in 2016. Manufacturing costs for all additional units would be reduced by $150 per unit (in addition to the $125,000 savings noted above).

• VacuTech is subject to a 40 percent income tax rate. For evaluating capital-investment proposals, management assumes that annual cash flows occur at the end of the year and uses a 15 percent after-tax discount rate.

Required:

1. Determine whether VacuTech should purchase the new pump by calculating the net present value (NPV) at January 1, 2013, of the estimated after-tax cash flows that would result from its acquisition.

2. Describe the factors, other than the net present value, that VacuTech should consider before making the pump replacement decision.