KCC must fully replace one of its fully depreciated canning machines. Two new mo

Question

KCC must fully replace one of its fully depreciated canning machines. Two new models are available: machine A, having a cost of $100,000 an expected life of 3 years, and a before tax cash flow savings of $55,000 per year; and machine B having a cost of $200,000, an expected life of 5 years and before tax cash flow savings of $80,000 per year. Machine A falls into the MACRS 3 year class, while machine B falls into MACRS 5 year class. Both machines will have an expected salvage value equal to their book value at the end of their expected lifes. Technological improvements are expected so that any machine purchased after 3 years will provide after tax profit depreciation cash flow that are 20 percent higher than present cash flows. However, machinery prices in 30 years are projected to rise 20%, offsetting the increased cash flows. After that time, KCC projects that machinery prices and cash flows will be constant. The firm's cost of capital is 15% and its federal plus state tax rate is 40%. If the replacement is to be made, it must be done now. Should KCC replace the old machine with one of the new models? Is so, with which alternative? Show all computations.

Explanation / Answer

yes it should replace

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