3. (40 Points) Otter must decide whether to replace a 10 year-old packing machin

Question

3. (40 Points) Otter must decide whether to replace a 10 year-old packing machine with a new one that costs$153,800. Replacing the old machine will increase net operating income(excluding depreciation) from$70,000 to $110,000 and it will decrease net working capital by $18,000. The new machine falls into MACRS 5-year class. If the new machine is purchased, it will be sold in 6 years for $25,000, whereas, if the old machine is kept, it will have no salvage value in 6 years. The old machine has a current market value of $10,860 and although its current book value is $8,000, in one year the old machine’s book value will be zero ($0). The firm’s marginal tax rate is 40% and its required rate of return is 12%. Should the new packing machine be purchased? Explain.

Depreciation

            NEW                          OLD

Year 1 -$22,760                 $ 8,000

Year 2 - $49,216                $ 0

Year 3 - $29,222                $ 0

Year 4 - $18,456                $ 0

Year 5 - $ 16,918               $ 0

Year 6 - $9,228                   $ 0

note*

tax cost of $1144 on disposal of the old machine ( 10,860 - 8000 X 40% )

The new depreciation for year 1 is $ 30,760 not 22,760 as stated , which makes the change in depreciation $ 22,760.

Explanation / Answer

Should select new packing system.

New Packing System Old Packing System New Packing System Old Packing System Before tax Amount Year Before tax Amount Year Profit PV Profit PV 97240 1 72860 1 58344 52092.86 43716 39032.14 78784 2 70000 2 47270.4 37683.67 42000 33482.14 98778 3 70000 3 59266.8 42184.94 42000 29894.77 109544 4 70000 4 65726.4 41770.32 42000 26691.76 111082 5 70000 5 66649.2 37818.55 42000 23831.93 143772 6 70000 6 86263.2 43703.62 42000 21278.51 255254 174211.3

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