Sunshine Cleaners currently uses a machine that was purchased 2 years ago for $8

Question

Sunshine Cleaners currently uses a machine that was purchased 2 years ago for $8,000. This machine is being depricated using straight-line, and it has 4 years of remaining depreciable life and 6 years of remaining useful life. The estimated market value at the end of its useful life is $0. The owner strongly believes the machine could be sold for $4,000 today. The firm is considering a replacemenet machine priced at $8,000, lasts for 6 years and have a market value of $800 at the end of its useful life. The replacement would permit an output expansion so sales wil be $1,000 higher (compared to the old machine) each year for 6 years. Also, operating expenses will be $1,500 less in each year. The new machine would require investnories be increased from today's level of $30,000 to $35,000 at end of Year 1, $40,000 at end of Y2, $42,000 at end of Years 3-5 and $30,000 at end of Year 6. The firm's tax rate is 40% and its cost of capital is 15%. Should the old machine be replaced? (Suggested item by item estimated).

Explanation / Answer

Depreciation 8000-800/6 year Incremental Benefits 0 -4000 -4000 1 -5000 1446.67 -3553.33 2 -5000 1446.67 -3553.33 3 -2000 1446.67 -553.33 Increased benefit Depreciation EBIT_Depreciation tax ocf 4 1446.67 1446.67 2500 1200 1300 520 1980 5 1446.67 1446.67 For first Machine (8000/6)*40% 533.33 6 1446.67 1446.67 Incremmental 1446.67 6 800 800 6 12000 12000 ($3,745.11) No replacement needed, results in negative npv

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