d. Should the machine be purchased? Explain your answer 12-10 REPLACEMENT ANALYS
ID: 2580517 • Letter: D
Question
d. Should the machine be purchased? Explain your answer 12-10 REPLACEMENT ANALYSIS T he Dauten Toy Corporation currently uses an injection mol 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 for $2,500 at this time. Thus, the annual depreciation expense is $2,100/6- $350 per year,Ie sold 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 11%. Should it replace the old machine?Explanation / Answer
First determine the net cash flow at t = 0:
Purchase price ($8,000)
Sale of old machine 2,500
Tax on sale of old machine (160)a
Change in net working capital (1,500)b
Total investment ($7,160)
a The market value is $2,500 – $2,100 = $400 above the book value. Thus, there is a $400 recapture o fdepreciation, and the company would have to pay 0.40($400) = $160 in taxes.
b The change in net working capital is a $2,000 increase in current assets minus a $500 increase in currentliabilities, which totals to $1,500
Annual cash inflows:
Sales increase $1,000
Cost decrease 1,500
Increase in pre-tax revenues $2,500
After-tax revenue increase:
2,500(1 – T) = $2,500(0.60) = $1,50
Depreciation:
Thus NPV = $1,908.47. As NPV is >0 the replacement should be done.
Calculations:
PVIF = 1/(1+11%)^n where n is the year of the cash flow
PV = cash flow amount*PVIF
NPV = sum of all PVs
Year 1 2 3 4 5 6 New 1,600.00 2,560.00 1,520.00 960.00 880.00 480.00 Old 350.00 350.00 350.00 350.00 350.00 350.00 Change 1,250.00 2,210.00 1,170.00 610.00 530.00 130.00 Depreciation tax savings 500.00 884.00 468.00 244.00 212.00 52.00Related Questions
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