Question

Example 1 JJ company wants to replace the old machine. Machine is used in molding the components. The old machine was acquired three year ago. Its remaining useful life is 5 years and salvage value is $10,000. Book value of old machine is $70,000. Old machine cash operating cost is $20,000 per year. A new machine is the speed accelerating machine. Its initial cost is $ 150,000. New machine cash 's operating cost is $12,000 per year. Its useful life is 5 years and salvage value is $40,000. The company use straight line in calculation of depreciation. If the new machine is purchased, the old machine can be sold at $75,000. Tax rate is 30%. Cost of capital is 8%.

Answer 1

Initial investment for new m/c	-150000
After-tax salvage of Old m/c(Refer wkgs.)	73500
PV of savings in after-tax cash operating costs (20000-12000)*(1-30%)*3.9927	22359	P/A
PV of incl.depn. Tax shields(10000*30%*3.9927)	11978	P/A
After-tax salvage of new m/c(BV=SV)(40000*0.6806)	27224	P/F
After-tax salvage of old m/c lost(BV,0> SV,10000)(10000*(1-30%)*0.6806)	-4764.2	P/F
NPV of the purchase decision	-19703
Replacement is not recommended as the NPV of the purchase decision is NEGATIVE.
P/F, i= 8% n=5 =0.6806
P/A,i=8% ; n= 5= 3.9927

Workings for:
After-tax salvage of old m/c
Book value	70000
Less:Salvage value	75000
Gain on sale	5000
Tax cash Outflow on gain(5000*30%)	1500
After-tax salvage(75000-1500)	73500
Annual Cash opg. Costs savings for 5 yrs.
New m/c	12000
Old m/c	20000
Savings	8000
After-tax savings(8000*(1-30%)=	5600
Depn. Of old m/c(70000-10000)/5	12000
Depn. Of new m/c(150000-40000)/5	22000
Incl.annual depn.	10000
annual Incl.depn.tax shield(10000*30%)	3000
After-tax salvage of new m/c
Cost	150000
Acc. Depn. (22000*5)	110000
Book value	40000
salvage	40000
Gain/Loss	0