Question

AFTER TAX SALVAGE VALUE Karsted Air Services is now in the final year of a project. The equipment originally cost $23 million, of which 80% has been depreciated. Karsted can sell the used equipment today for $5.75 million, and its tax rate is 40%. What is the equipment's after-tax salvage value? Round your answer to the nearest dollar. Write out your answer completely. For example, 13 million should be entered as 13,000,000. $ ________

4. REPLACEMENT ANALYSIS The Oviedo Company is considering the purchase of a new machine to replace an obsolete one. The machine being used for the operation has a book value and a market value of zero. However, the machine is in good working order and will last at least another 10 years. The proposed replacement machine will perform the operation so much more efficiently that Oviedo's engineers estimate that it will produce after-tax cash flows (labor savings and depreciation) of $6,000 per year. The new machine will cost $40,000 delivered and installed, and its economic life is estimated to be 10 years. It has zero salvage value. The firm's WACC is 10%, and its marginal tax rate is 35%. Should Oviedo buy the new machine? Oviedo _________________ purchase the new machine.

Answer 1

1.

Salvage
Purchase price	23,000,000.00
Less: Depreciation	18,400,000.00
Closing book value	4,600,000.00
Selling price	5,750,000.00
Gain/(loss)	1,150,000.00
Tax	402,500.00
Net salvage	5,347,500.00

2.  

Year	Initial cash flow	Cash flows
0	-40000
1		$6,000.00
2		$6,000.00
3		$6,000.00
4		$6,000.00
5		$6,000.00
6		$6,000.00
7		$6,000.00
8		$6,000.00
9		$6,000.00
10		$6,000.00
	NPV	($3,132.60)

NPV = - Initial cost + 6000*(P/A,10%,10 years)

Since NPV is negative, the machine should not be purchased.