Question

A computer chip manufacturer spent $2,540,000 to develop a special-purpose molding machine. The machine has been used for one year and is expected to be obsolete after an additional 3 years. The company uses straight-line (SLN) depreciation for this machine.

At the beginning of the second year, a machine salesperson offers a new, vastly more efficient machine. This machine will cost $2,040,000, reduce annual cash manufacturing costs from $1,840,000 to $1,040,000, and have zero disposal value at the end of 3 years. Management has decided to use the double-declining-balance (DDB) depreciation method for tax purposes for this machine if purchased. (Note: Make sure to switch to SLN depreciation in year 3 to ensure that the entire cost of the asset is written off. You may find it useful to use the VDB function in Excel to calculate depreciation charges.)

The old machine’s salvage value is $304,000 now and is expected to be $54,000 three years from now; however, no salvage value is provided in calculating straight-line (SLN) depreciation on the old machine for tax purposes. The firm’s income tax rate is 45%. The firm desires to earn a minimum after-tax rate of return of 8%. (Use Table 1 and Table 2.) (Do not round intermediate calculations.)

Required:
Note: Use the PV and NPV functions in Excel to calculate all present value amounts.
1. What is the present value of tax savings associated with depreciating the existing machine (using the straight-line method)? (Round your final answer to the nearest whole dollar.)
2. What is the present value of tax savings associated with depreciating the new machine using the double-declining-balance method? Use the VDB built-in function in Excel to calculate depreciation deductions. (Round your final answer to the nearest whole dollar.)
3. What is the present value of net after-tax cost associated with the existing machine? (Hint: there will be three items to consider.) (Round your final answer to nearest whole dollar amount.)
4. What is the present value of the net after-tax cost of using the replacement (new) machine? (Round your final answer to the nearest whole dollar.)
5. What is the estimated net present value (NPV) of the decision to replace the existing machine with the new machine. (Round your final answer to the nearest whole dollar.)

	1. Present value 2. Present value 3. Present value 4. Present value 5. Estimated net present value

Answer 1

Answer 1)

Calculation of Depreciation for Old Machinery (Under Straight Line Method)
Purchase value	Salvage Value	Life Time(Years)
$ 25,40,000.00	$                     -	3
year	deperciation	Book Vaue
1	$ 8,46,666.67	$            16,93,333.33
2	$ 8,46,666.67	$               8,46,666.66
3	$ 8,46,666.66	$                                  -

	Calculation of Present value of Total Cash flows savings on account of Depreciation of old Machinery
	Discount rate	8%
year	Cash flows(Savings in Depreciation on old Machinery	PV Factor	PV of Cash Flows
1	$                           8,46,666.67	0.925925926	$         7,83,950.62
2	$                           8,46,666.67	0.85733882	$         7,25,880.20
3	$                           8,46,666.66	0.793832241	$         6,72,111.29
	$                         25,40,000.00	Total PV Cash flows	$       21,81,942.12

Answer 2)

Calculation of Depreciation for New Machinery (Under Double Declining Method)
Orginal cost	$ 20,40,000.00
Salvaged value	0
Life	3
	book value	Depreciation	Depreciation	Accumulated	book Value
Period	Start	percent	Expenses	Depreciation	End
1	$ 20,40,000.00	67%	$      13,60,000.00	$ 13,60,000.00	$ 6,80,000.00
2	$    6,80,000.00	67%	$        4,53,333.33	$ 18,13,333.33	$ 2,26,666.67
3	$    2,26,666.67	67%	$        1,51,111.11	$ 19,64,444.44	$     75,555.56

Calculation of Present value of Total Cash flows savings on account of Depreciation of New Machinery
Discounting Rate	8
period	PV Factor	Cash flows(Savings in Depreciation on New Machinery	PV of Cash Flows
1	0.92592	$ 13,60,000.00	$      12,59,251.20
2	0.85733	$    4,53,333.33	$        3,88,656.26
3	0.79383	$    1,51,111.11	$        1,19,956.53
		Total PV of Cash Flows	$ 17,67,864

Note : Here Both the Machineries have no salvaged value