Chris Technologies considering replacing one of its printed circuit board machin

Question

Chris Technologies considering replacing one of its printed circuit board machines with one that is newer and more efficient. The firm purchased the machine 10 years ago at a cost of $150,000. The machine had an expected economic life of 12 years at the time of purchase and an expected salvage value of $12,000 at the end of the 12 years. The original salvage estimate is still good and the machine has a remaining useful life of 2 years. The firm can sell this old machine now to another firm for $35,000. A new machine can be purchased for $175,000 including installation costs. It has an estimated useful (economics) life of 8 years. The new machine is expected to reduce cash operating expenses by $30,000 per year over its 8 years life, at the end of which the machine is estimated to be worth only $5000. The asset is classified as a class 43 property with a CCA of 30%. The firm’s marginal tax rate is 40% and MARR of 12%. Determine

• The opportunity (investment) cost of retaining the old asset?

• The cash flows associated with retaining the old machine in years 1 to 2.

• The cash flows associated with purchasing the new machine in years 1 to 8. (use the opportunity cost concept.)

• If the firm needs the service of these machines for an indefinite period and no technology improvement is expected in future machines, what will be your decision?

Explanation / Answer

1) Opportunity Cost of Retaining the old Assets = sale price = tax shield on dep + operating Cost (11500*2)*40%+30000*2*60%(i.e operating Cost) 45200 2) cash flows associated with retaining the old machine in years 1 to 2. Year Operating cost tax shield on Depreciation total Discounting Factor @ 12% Dicounted cash flow 1 30000*(1-.40) 11500*40% -13400 0.893 -11966.2 2 30000*(1-.40) 11500*40% -13400 0.797 -10679.8 -22646 3) cash flows associated with purchasing the new machine in years 1 to 8. Year cash flow tax Saving total Discounting Factor @ 12% Dicounted cash flow 0 -175000 0 -175000 1 -175000 1 30000*60% (175000*30%+21250)*40% 47500 0.893 42417.5 2 30000*60% 21250*40% 26500 0.797 21120.5 3 30000*60% 21250*40% 26500 0.712 18868 4 30000*60% 21250*40% 26500 0.636 16854 5 30000*60% 21250*40% 26500 0.567 15025.5 6 30000*60% 21250*40% 26500 0.507 13435.5 7 30000*60% 21250*40% 26500 0.452 11978 8 5000+30000*60% 21250*40% 31500 0.404 12726 -22575

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