Amigo Ltd is considering investing in a new machine which has a capital cost of $$ 25,000$.
Question:
Amigo Ltd is considering investing in a new machine which has a capital cost of $\$ 25,000$. It has an estimated life of four years and a residual value of $\$ 5,000$ at the end of four years. The machine qualifies for tax depreciation at the rate of $25 \%$ per year on a reducing balance basis.
An existing machine would be sold immediately for $\$ 8,000$ if the new machine were to be bought. The existing machine has a tax written down value of $\$ 3,000$.
The existing machine generates annual net contribution of $\$ 30,000$. This is expected to increase by $40 \%$ if the new machine is purchased.
Amigo pays corporation tax on its profits at the rate of $30 \%$, with half of the tax being payable in the year that the profit is earned and half in the following year. The company's after tax cost of capital is $15 \%$ per year.
Calculate whether the investment is worthwhile. Should Amigo invest in the new machine?
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