11.4 Duluth Medico purchased a digital image-processing machine three years ago
ID: 2435976 • Letter: 1
Question
11.4 Duluth Medico purchased a digital image-processing machine three years ago at a cost of $50,000. The machine had an expected life of eight years at the time of pur- chase and an expected salvage value of $5,000 at the end of the eight years. The old machine has been slow at handling the increased business volume, so management is considering replacing the machine. A new machine can be purchased for $85,000, including installation costs. Over its five-year life, the machine will reduce cash op erating expenses by $30,000 per year. Sales are not expected to change. At the end of its useful life, the machine is estimated to be worthless. The old machine can be sold today for $10,000. The firm's interest rate for project justification is known to be 15%. The firm does not expect a better machine (other than the current challenger) to be available for the next five years. Assuming that the economic service life of the new machine, as well as the remaining useful life of the old machine, is five years, versus purchasing the challenger). (b) Should the company replace the defender now?Explanation / Answer
Old Machine : 1 2 3 4 5 Total Saving in operating expenses 0 0 0 0 0 Depreciation 10000 10000 10000 Salvage 5000 Tax @ 35% -1750 10,000 10,000 10,000 - 3,250 PV @ 15% 1 1 1 1 0 PV of Cash Flow 8,696 7,561 6,575 - 1,616 24,448 New Machine : Old Machine : 1 2 3 4 5 Total New Machine Cost : -85000 Sale Value 10000 Tax on Loss of Existing asset sale 7000 Saving in operating expenses 30000 30000 30000 30000 30000 Tax @ 35% -10500 -10500 -10500 -10500 -10500 Depreciation 17000 17000 17000 17000 17000 Total (31,500) 36,500 36,500 36,500 36,500 PV @ 15% 1 1 1 1 0 PV of Cash Flow (27,391) 27,599 23,999 20,869 18,147 63,223
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