Question

Komatsu Cutting Technologies is considering replacing one of its CNC machines with one that is newer and more efficient. The firm purchased the CNC machine 12 years ago at a cost of $132,000. The machine had an expected economic life of 16 years at the time of purchase and an expected salvage value of $13,000 at the end of the 16 years. The original salvage estimate is still good, and the machine has a remaining useful life of 4 years. The firm can sell this old machine now to another firm in the industry for $35,000. The new machine can be purchased for $161,000, including installation costs. It has an estimated useful (economic) life of 8 years. The new machine is expected to reduce cash operating expenses by $34,000 per year over its 8 year life, at the end of which the machine is estimated to be worth only $3,000. The firm's marginal tax rate is 39%, and its after-tax MARR is 14%. The new machine is classified as a seven-years MACRS and the old machine is already fully depreciated. If the firm needs the service of these machines for an indefinite period and no technology improvement is expected in future machines, should Komatsu Cutting purchase the new machine now or keep the old machine? Enter the ANNUAL EQUIVALENT COST of the preferred alternative as a positive number. Include the reduced operating expenses of the new machine as revenue in your analysis of the cash flow for the new machine.

Answer 1

working notes
:1. tax rate is 39%.So after tax saving in costs =34000 x61%= 20740

2. dep reciation rates as per MACRS table are 14.29,24.49,17.49,12.49,8.93,8.92,8.93and4.46

3.tax savings on incremental dep = dep x 39%

CASH FLOWS FOR EPLACEMENT PROJECT

PARTICULARS	YEAR0	YR1	YR2	YR3	YR4	YR5	yr6	yr7	yr8
1.cost of new asset	(161000)
2.sale value of old asset	350000
3. total net investment (col1 -2)	(126000)
OPERATING INFLOWS
4.after tax savings in operating costs		20740	20740	20740	20740	20740	20740	20740	20740
5. incremental depreciation		23007	39429	28159	20109	14377	14361	14377	7181
6.tax savings on incremental dep		8973	15377	10982	7843	5607	5601	5607	2801
7. net operating cashflow(4 +60		29713	36117	31722	28583	26347	26341	26347	23541
TERMINAL CASHFLOW
8.net salvage value of new machine									3000
9.salvage value of old machine had it been retained					(13000)
10.total terminal cashflow (8 -9)					(13000)				3000
11. net cashflow(3+7+10)	(126000)	29713	36117	31722	15583	26347	26341	26347	20541

since MARR is 14%, we discount the cash inflows at 14%

Present value of cash inflows=

29713x0.877 +36117x0.769+31722x0.675 +15583x0.592 +26347x 0.519 +26341x 0.456 +26347x0.400 +20541x 0.351 = 127904

present value of outflows= 126000

so NPV= present value of inflows- present value of outflows= 127904-126000= $1904

Since NPV is positive , the company should go for replacement

equivalent annual cost = NPV/present value annuity factor at 14% for 8 yrs

=1904/4.639= $410.43