Question

The Woodruff Corporation purchased a piece of equipment three years ago for $230,000. It has an asset depreciation range(ADR) midpoint of 8 years. The old equipment can be sold for $90,000. A new piece of equipment can be purchased for$320,000. It also has an ADR of 8 years. Assume the old and new equipment would provide the following operating gains (or losses) over the next 6 years.

Year New Equipment Old Equipment

1 $80,000 $25,000

2 76,000 16,000

3 70,000 9,000

4 60,000 8,000

5 50,000 6,0000

6 45,000 (7,000)

The firm has a 25 percent tax rate and a 9 percent cost of capital. Should the new equipment be purchased to replace the old equipment?

Answer 1

The new equipment should not be purchased and replaced with the old equipment as the NPV after the purchase of new equipment will be negative .

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