A company is considering buying a new machine for $1,200,000. The new machine will replace the current

Question:

A company is considering buying a new machine for $1,200,000. The new machine will replace the current machine, which can be sold now for $75,000. The company will incur installation costs of $130,000 if it buys the new machine. The company's tax rate is 35% and its cost of capital after tax is 12%.

Buying the new machine would generate the following annual savings:

Year 1 ..........................$130,000

Year 2 ..........................140,000

Year 3 ..........................150,000

Year 4 ..........................175,000

Year 5 ..........................180,000

Year 6 ..........................185,000

Year 7 ..........................195,000

If the company decides to keep the old machine for 7 more years, it will have to spend $45,000 in 3 years from now for a complete refurbishment. On the other hand, if the company decides to buy the new machine, it would have to spend $40,000 for maintenance in year 5. In 7 years, the salvage value of the new machine would be $120,000, and the salvage value for the old machine would be $30,000. The capital cost allowance for this type of machine is 15%.

REQUIRED

Compute the net present value for the acquisition of the new machine and state whether the company should proceed with the investment or not?

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