Below is the selected information from the company’s financial statements.

	Book Value (Million)	Market Value (Million)	Cost of Capital
Long-Term Debt	200	200	10%
Common Stock	400	1000	20%

Now the company needs to decide whether to keep or replace the old equipment. The tax rate is 40%. There are two choices and here are their consequences:

a) Keep existing equipment - it generates $5M with maintenance costs equal to 60% of sales. Its book value is $3M and it depreciates over 7 years (1/7 each year).

b) Buy new equipment - it generates $5.5M in sales with maintenance costs equal to 50% of sales. It requires an immediate investment of $12M. The old machine is sold for $1.8M after an additional one-time depreciation of $1.2M. It also requires a one-time increase in inventory of $500K and a reduction in year 7.

What should the company do?

	A.	I am not sure
	B.	The company should replace the equipment
	C.	The company should keep old equipment
	D.	The two choices are the same

Answer rating: 100% (QA)

Answer Finding the NPV of Replacement Comparison Existing Equipment New Equipment Incremental amt Annual Machine cost 3000000 12000000 Useful life in ... View the full answer