John the CEO of A Ltd is thinking of replacing a dicing machine. A Ltd has a
Question:
John the CEO of A Ltd is thinking of replacing a dicing machine. A Ltd has a beta of 1.15 and 20-year government bonds are yielding 2%. The manufacturing stocks are returning a 4% return on average per year. A Ltd currently has a financial leverage of 30%, with total assets of $250 000. The debt is costing 8% per annum.
The old dicing machine cost $50 000; the new one will cost $30 000. The new machine will be depreciated to zero over 5-year life. It will be worth nothing after 5 years, but taxable dismantling costs of $9 000 will be incurred.
The old dicing machine is being depreciated at a rate of $ 5 000 per year. It will be completely written off in 5 years. If John does not replace it now, he will have to replace it in 5 years. John can sell it now for $12 000. In five years, it will probably be worth nothing.
The new machine will have a taxable savings of $6 000 per year in running cost. The corporate tax rate is 30 percent and tax is paid in the year of income.
Required
Should John purchase the new machine? Justify your answer and show all calculations
