the baltic company is considering the purchase of a new machine tool to replace
ID: 2344652 • Letter: T
Question
the baltic company is considering the purchase of a new machine tool to replace an obsolete one. the machine being used for the operation has a tax book value of $80,000 with an annual depreciation expense of 8,000. it has a salvage value of 40,000, is in good working condition, and will last at least 10 more years. the proposed machine will perform the operation so much more efficiently that baltic engineers estimate that labor, material, and other direct costs of the operation will be reduced 60,000 a year if it is installed. the proposed machine costs 240,000 delivered and installed, and it's economic life is estimated at 10 years, with zero salvage value. the company expects to earn 14% on it's investment after taxes(14% is the firm's cost of capital). the tax rate is 40% and the firm uses straighline depreciation. Any gain or loss on the machine is subject to tax at 40 percent. Should baltic buy the new machine?Explanation / Answer
40% of 60000 profit each year is tax =24000
hence net profit =36000
present value at 14 % = 36000/(1.14) +36000/1.14^2 .... 36000/1.14^11 =187780
....profit on machine=187780-240000 = -52219
hence baltic should not buy new machine
.......
for old machine tax reduce by depreciation =40% of 8000 =3200
hence present value =3200/1.14 +3200/1.14^2 ...3200/1.14^11 =16691
present value of salvage =40000/1.14^11 =9464.7
profit on machine=80000-16691-9464.7 =-53844.3
as calcuated profit on new machine is greater hence
baltic should not buy new machine.
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