(CMA, adapted) The Frooty Company is a family-owned business that produces fruit jam. The company has a grinding machine that has been in use for 3 years. On January 1, 2014, Frooty is considering the purchase of a new grinding machine. Frooty has two options: (1) continue using the old machine or (2) sell the old machine and purchase a new machine. The seller of the new machine isn't offering a trade-in. The following information has been obtained:

Frooty is subject to a 34% income tax rate. Assume that any gain or loss on the sale of machines is treated as an ordinary tax item and will affect the taxes paid by Frooty in the year in which it occurs. Frooty's after-tax required rate of return is 12%. Assume all cash flows occur at year-end except for  initial investment amounts.

1. How much more or less would the recurring after-tax cash operating savings of the new machine need to be for Frooty to be indifferent about whether to keep the old machine or buy the new machine? Assume that all other data about the investment remains the same.

Answer: Annual reduction in operating costs = $4,916

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Initial purchase cost of machines Useful life from acquisition date (years) Expected annual cash operating costs Old Machine $ 150,000 $ 8 New Machine 190,000 Variable cost per can of jam $ Total fixed costs $ 0.25 $ 25,000 $ 0.19 24,000 Depreciation method for tax purposes MACRS, 7 year asset MACRS, 5 year asset Estimated disposal value of machines January 1, 2014 $ 68,000 $ 190,000 December 31, 2018 $ 12,000 $ 22,000 Expected cans of jam produced and sold each year 475,000 475,000 5 Initial purchase cost of machines Useful life from acquisition date (years) Expected annual cash operating costs Old Machine $ 150,000 $ 8 New Machine 190,000 Variable cost per can of jam $ Total fixed costs $ 0.25 $ 25,000 $ 0.19 24,000 Depreciation method for tax purposes MACRS, 7 year asset MACRS, 5 year asset Estimated disposal value of machines January 1, 2014 $ 68,000 $ 190,000 December 31, 2018 $ 12,000 $ 22,000 Expected cans of jam produced and sold each year 475,000 475,000 5