Question: You are trying to decide whether to replace a machine on your production line. The new machine will cost $5 million, but will be more

You are trying to decide whether to replace a machine on your production line. The new machine will cost $5 million, but will be more efficient than the old machine, reducing costs by $1,500,000 per year. Your old machine is fully depreciated, but you could sell it for $100,000.

You would depreciate the new machine over a 5year life using MACRS. The new machine will not change your working capital needs. Your tax rate is 40% and your cost of capital is 9%. For clarity, assume that the new machine is purchased and put into use in December of year 0, allowing the partial year depreciation in year 0.

Should you replace the machine?

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