Suppose you have to decide whether sell an old machine or keep it with a major o

Question

Suppose you have to decide whether sell an old machine or keep it with a major overhaul. You can: A) Sell the machine at time zero for X dollars with zero book value and paying the tax of 40%. B) Keep the machine, which requires a major overhaul cost of $1,000,000 at time zero. The overhaul cost is depreciable from time 0 to year 5 (over six years) based on MACRS 5-year life depreciation with the half year convention (table A-1 at IRS). In this case machine can produce and generate equal annual revenue of 900,000 dollars for five years (year 1 to 5) and salvage value of the machine will be $250,000 with zero book value at the end of year 5. The operating cost of the machine will be $400,000 per year from year 1 to year 5. Calculate the sale value, X, that can break-even the NPV of keeping the machine. Consider 40% income tax rate and after-tax minimum ROR of 16%.

Explanation / Answer

Break even will be before tax = 287065/(1-0.4)*100

= $478440

Depreciation Schedule # Year Basis % Depreciation
Expense Accumulated
Depreciation Ending
Book Value M 1 2001 $1,000,000 20.000% $200,000 $200,000 $800,000 DB 2 2002 $1,000,000 32.000% $320,000 $520,000 $480,000 DB 3 2003 $1,000,000 19.200% $192,000 $712,000 $288,000 DB 4 2004 $1,000,000 11.520% $115,200 $827,200 $172,800 SL 5 2005 $1,000,000 11.520% $115,200 $942,400 $57,600 SL 6 2006 $1,000,000 5.760% $57,600 $1,000,000 $0 SL

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