Question

A company is thinking about replacing an old machine with a new one. The old machine cost $1.3 million. The new machine will cost $1.56 million. The new machine will be depreciated according to 5-year MACRS, and will be sold at $300,000 after 5 years. The new machine will require an investment of $150,000 in working capital, which can be recovered after 5 years. The old machine is being depreciated at a rate of $130,000 per year, and can be sold for $50,000 after 5 years. It can be sold for $300,000 now. The company is in a 30% tax bracket and applies a 12% discount rate. Should the company replace the old machine with the new one?

Answer 1

Answer :

Given that,

Computation of initial incremental cash outflows:

year	Particulars	Amount	PV	discounted present value
a	b	c	d	e = c * d
0	cost of new machine	1,560,000	1	1,560,000
	add : working capital	150,000	1	150,000
	less : proceeds from sale of old machine	300,000	1	-300,000
	incremental cash outflows			1,410,000

Statement showing incremental cash inflows:

year	incremental revenue ( salvage value and working capital )	incremental deprciation	incremental profit before tax	tax @ 30%	incremental profit after tax	net cash out flows	discount @ 12%	pv of discounted value
a	b	c	d = b - c	e = d * 30%	f = d - e	g = f + c	h = ( 1 / 1.12)^a	i = g * h
1		122,000	-122,000	-36,600	-85,400	36,600	0.893	32,678.57
2		122,000	-122,000	-36,600	-85,400	36,600	0.797	29,177.3
3		122,000	-122,000	-36,600	-85,400	36,600	0.712	26,051.16
4		122,000	-122,000	-36,600	-85,400	36,600	0.636	23,259.96
5		122,000	-122,000	-36,600	-85,400	36,600	0.567	20,767.82
5	250,000		250,000	75,000	175,000	175,000	0.567	99,299.7
5	150,000		150,000	45,000	105,000	105,000	0.567	59,579.82

Incremental cash inflows = 290,814.3

since incremental cash outflows are more than incremental cash inflows , it is advised not to go for replacement.

working notes :

1.Incremental salvage value = new machine salvage value - old machine salvage value

Incremental salvage value = $300000-$50000

Incremental salvage value = $250000

2.incremental depreciation =

Depreciation for old machine = $130000

Depreciation for new machine = (cost of the asset - salvage value )/useful life

Depreciation for new machine = ($1560000-$300000)/5=$252000

3. . Tax effect  on proceeds from sale of old machine is not considered since book vlaue of the machine is not given

4.working capital should not be considered for cost of the asset

5. since revenue information is not preset in the question , that colum is not blank.