Otter must decide whether to replace a 10 year-old packing machine with a new one that costs$153,800. Replacing the old machine will increase net operating income(excluding depreciation) from$70,000 to $110,000 and it will decrease net working capital by $18,000. The new machine falls into MACRS 5-year class. If the new machine is purchased, it will be sold in 6 years for $25,000, whereas, if the old machine is kept, it will have no salvage value in 6 years. The old machine has a current market value of $10,860 and although its current book value is $8,000, in one year the old machines book value will be zero ($0). The firms marginal tax rate is 40% and its required rate of return is 12%. Should the new packing machine be purchased? Explain.

Depreciation

NEW OLD

Year 1 -$22,760 $ 8,000

Year 2 - $49,216 $ 0

Year 3 - $29,222 $ 0

Year 4 - $18,456 $ 0

Year 5 - $ 16,918 $ 0

Year 6 - $9,228 $ 0

note*

tax cost of $1144 on disposal of the old machine ( 10,860 - 8000 X 40% )

The new depreciation for year 1 is $ 30,760 not 22,760 as stated , which makes the change in depreciation $ 22,760.