ALC corp is considering replacing an old machine used in production with a new technically improved one.
Question:
ALC corp is considering replacing an old machine used in production with a new technically improved one. This old machine has 10 more years of useful life, its current book value is $800,000 and its current market value is $950,000. After 10 years the residual value will be $200,000. The old machine will be sold if the company decides to buy the new machine.
The new technically improved machine costs $2 million. It will be used for 10 years and the residual value will be $500,000. The new machine will have lower operating costs.
The annual operating costs information for both machines are as follows
Old machine new machine
For first 5 years $400,000 $100,000
For next 3 years $450,000 $180,000
For last 2 years $480,000 $240,000
Both machines will be overhauled after 5 years (end of year 5). If the company continued with old machine the overhaul cost will be $80,000. Overhaul cost for new machine will be $50,000.
The company’s income tax rate is 25%. The required rate is 12%.
- 1- Calculate the net after tax cash investment if new machine is purchased.
- 2- Calculate the after tax cash flows for each year if the new machine is purchased and used
- 3- Calculate the after tax cash flows for each year if the old machine is used.
- 4- Using NPV analysis and your answer for question 1 and 2, determine if the company should buy the new machine.
Accounting
ISBN: 978-0324662962
23rd Edition
Authors: Jonathan E. Duchac, James M. Reeve, Carl S. Warren