Reference no: EM13346333
The Dauten Toy Corporation currently uses an injection molding machine that was purchased 2 years ago. This machine is being depreciated on a straight-line basis, and it has 6 years of remaining life. Its current book value is $2,100, and it can be sold for $2,500 at this time. Thus, the annual depreciation expense is $2,100/6 = $350 per year. If the old machine is not replaced, it can be sold for $500 at the end of its useful life.
Dauten is offered a replacement machine which has a cost of $8,000, an estimated useful life of 6 years, and an estimated salvage value of $800. This machine falls into the MACRS 5-year class so the applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. the replacement machine would permit an output expansion, so sales would rise by $1,000 per year; even so, the new machine's much greater efficiency would cause operating expenses to decline by $1,500 per year. the new machine would require that inventories be increased by $2,000, but accounts payable would simultaneously increase by $500. Dauten's marginal federal-plus-state tax rate is 40%, and its WACC is 15%. Should it replace the old machine?
Here we have the calculation to find the solution.
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Net cash flow at t = 0: |
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Purchase price |
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Sale of old machine |
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Tax on sale of old machine |
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Change in net working capital |
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Total investment |
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Annual cash inflows: |
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Sales increase |
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Cost decrease |
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Pre-tax revenue increase |
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Tax benefit |
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After-tax revenue increase |
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Depreciation: |
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Year 1 |
Year 2 |
Year 3 |
Year 4 |
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New |
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Old |
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Change |
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Depreciation tax savings |
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Calculate NPV: |
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Year 0 |
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
Year 6 |
Net investment |
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After-tax revenue increase |
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Depreciation tax savings |
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Working capital recovery |
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Salvage value of new machine |
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Tax on salvage value |
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Opportunity cost of old machine |
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Project cash flows |
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NPV = |
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Replace old machine (Yes/No)? |
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