Question
In: Accounting
Suppose Amazon is considering replacing an old packaging system with a new one. The old system...
Suppose Amazon is considering replacing an old packaging system with a new one. The old system has a book value of $50,000 and a remaining life of 10 years and could be sold for $75,000 right now. The new machine costs $150,000 and has a depreciable life of 10 years, annual operating costs $40,000 lower than the old machine. Assuming straight line depreciation, 40% tax rate, and no salvage value on either machine at the end of 10 years, should the company replace the old packaging system?
Solutions
Expert Solution
Ans:
New Machine Cost: $150,000
Old equipment sale value : $75,000
Additional cost of buying new machine : $150,000 - $75,000 = $75,000
Annual Operating costs saving : $40,000
Annual Depriciation Benefit : (New Machine cost - old machine book value) / 10 = $10,000
After Tax Annual Benifits = ($40,000 + $10,000) * (1-40%) = $30,000
So for an additional cost of $75,000 will save $300,000 ( $30,000*10) for over 10 years period. Therefore as per IRR method it gives a after tax return of 38% on additional capital of $75,000 used. So company should replace the existing machine.
Use the formula below to get IRR is excel.
| Intial cost | -75000 |
| Benfits Year 1 | 30000 |
| 2 | 30000 |
| 3 | 30000 |
| 4 | 30000 |
| 5 | 30000 |
| 6 | 30000 |
| 7 | 30000 |
| 8 | 30000 |
| 9 | 30000 |
| 10 | 30000 |
| =IRR(B1:B11) |
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