Question: Pilot Plus Pens is deciding when to replace its old
Pilot Plus Pens is deciding when to replace its old machine. The machine’s current salvage value is $2.2 million. Its current book value is $1.4 million. If not sold, the old machine will require maintenance costs of $845,000 at the end of the year for the next five years. Depreciation on the old machine is $280,000 per year. At the end of five years, it will have a salvage value of $120,000 and a book value of $0. A replacement machine costs $4.3 million now and requires maintenance costs of $330,000 at the end of each year during its economic life of five years. At the end of the five years, the new machine will have a salvage value of $800,000. It will be fully depreciated by the straight-line method. In five years a replacement machine will cost $3,200,000. Pilot will need to purchase this machine regardless of what choice it makes today. The corporate tax rate is 40 percent and the appropriate discount rate is 8 percent. The company is assumed to earn sufficient revenues to generate tax shields from depreciation. Should Pilot Plus Pens replace the old machine now or at the end of five years?
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