Reference no: EM133715986

Question: Today's date is December 31, 2023. Selected items from the pro-forma income statement for the Isabella Company for the next five years are as follows:

Revenues 100,000/year

Operating costs -50,000/year

EBT 20,000/year

Taxes -8,000/year

Net income 12,000/year

To improve this projected performance, the firm is considering replacing one of its machines. The replacement is not expected to affect revenues, but operating costs would be reduced by 10%. The old machine was purchased three years ago for $40,000 and could now be sold for $20,000. It was estimated to have an eight-year economic life, with an expected salvage value of 0 at the end of its life. The new machine costs $30,000. It has a five-year economic life and no salvage value. Tax rules prescribe straight-line depreciation over seven years for the old machine and five years for the new machine. The opportunity cost of capital is 12%. Note that the items in the income statement are for the entire firm, not just a specific project. Also, note that the economic life of the asset refers to the number of years that the asset can be used for production; the number of years that the company can claim depreciation expense (based on tax rules) might be different from the number of years that the asset can be used for its economic life. Assume all cash flows (including taxes) are realized at the end of each year.

Should the Isabella Company purchase the new machine?