You are considering replacing a machine in your factory. The current machine cost $500,000 seven years ago. It is being depreciated for tax purposes on a straight-line basis over its ten year life. The old machine can be sold today for $150,000 or you can sell it in three years for $100,000.

The new machine would cost $700,000 and it would fall into the three-year MACRS classification. The MACRS three-year depreciation rates are 33%, 45%, 15%, and 7%. If the new machine is purchased, it would be operated for three years and then sold for $250,000. You are considering the new machine because it would result in labor savings of $150,000 per year. If you purchase the new machine, net working capital requirements will increase by $50,000 because of the need for more spare parts.

If your tax rate is 40% and your cost of capital is 10% per year, what is the net present value of purchasing the new machine? What should you do?

			Dep OLD
Old Machine	500,000		1	2	3	4	5	6	7	8	9	10
Depreciation	SL 10
Salvage Value TODAY	150,000
Salvage Value 3 years	100,000
New Machine	700,000		Dep NEW
Depreciation	3-yr MACRS		1	2	3	4
Tax Rate	40%
WACC	10%
New Machine Salvage	250,000
Life	3	years