Toy Company currently uses a machine that was purchased 2 years ago for $8,000.
ID: 2731091 • Letter: T
Question
Toy Company 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 $40,000 to $45,000 at end of Year 1, $50,000 at end of Y2, $52,000 at end of Years 3-5 and 40,000 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? Please show specific calculations for each number shown! Found this very challenging.
Explanation / Answer
Answer
Figures in $
Year
Increase in sales
Saving in operating Expenses
Total Saving after tax
Depreciation tax benefit
Purchase of new machine
Sale of old machine
working capital
Cash flow
Disc Rate : 15%
Present value
A
B
C
D
E
F
G
H
I
(A+B)*(1-tax rate)
((8000-800)/6)*Tax rate
C+D+E+F+G
H*I
0
-8000
4000
-4000
1
-4000.00
1
1000
1500
1500
480
-5000
-3020
0.869565
-2626.09
2
1000
1500
1500
480
-5000
-3020
0.756144
-2283.55
3
1000
1500
1500
480
-2000
-20
0.657516
-13.15
4
1000
1500
1500
480
0
1980
0.571753
1132.07
5
1000
1500
1500
480
0
1980
0.497177
984.41
6
1000
1500
1500
480
800
12000
14780
0.432328
6389.80
Net Present value
-416.51
Answer : As Net present value is -416.51 so the old machine should not be replaced
Figures in $
Year
Increase in sales
Saving in operating Expenses
Total Saving after tax
Depreciation tax benefit
Purchase of new machine
Sale of old machine
working capital
Cash flow
Disc Rate : 15%
Present value
A
B
C
D
E
F
G
H
I
(A+B)*(1-tax rate)
((8000-800)/6)*Tax rate
C+D+E+F+G
H*I
0
-8000
4000
-4000
1
-4000.00
1
1000
1500
1500
480
-5000
-3020
0.869565
-2626.09
2
1000
1500
1500
480
-5000
-3020
0.756144
-2283.55
3
1000
1500
1500
480
-2000
-20
0.657516
-13.15
4
1000
1500
1500
480
0
1980
0.571753
1132.07
5
1000
1500
1500
480
0
1980
0.497177
984.41
6
1000
1500
1500
480
800
12000
14780
0.432328
6389.80
Net Present value
-416.51
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