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 $130,000. The machine had an expected economic life of 15 years at the time of purchase and an expected salvage value of $12,000 at the end of the 15 years. The original salvage estimate is still good, and the machine has a remaining useful life of 3 years. The firm can sell this old machine now to another firm in the industry for $30,000. The new machine can be purchased for $162,000, including installation costs. It has an estimated useful (economic) life of 8 years. The new machine is expected to reduce cash operating expenses by $32,000 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 33%, and its after-tax MARR is 13%. 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

Evaluation of proposal for buying new CNC machine now

Cash outflows

Cost of new machine 162000

Sale value of old machine (30000)

............

Net cash outflow 130000

Tax savings on capital loss (33000) (Sale value - Cost old machine = 100000 * 33%)

old machine ( as may be applicable under the US Taxation laws. In this question, tax rate for capital loss has been taken as 33% as given in question.)

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Present value of cash outflow = 99000

  

Cash inflows

Amount Time PVf (13%) Present value

Savings in operating cost of old machine 32000 1-8 4.7988 153561.6

Tax savings on incremental depriciation (See notes) 1-8 35269

Scrap value at life end 3000 8 0.37616 1128.48

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Present value of cash inflows 189959.08

Net present value = PV cash inflows - PV cash outflows

= 189959.08 - 99000

= 90959.08$

Hence, it advisable for the company to purchase the new machine now and sell the old machine since the net present value analysis of this proposal is favourable and positive for company.

Note 1 - Calculation of tax savings on incremental depriciation using MACRS (7 years) table

Year Depriciation Tax saving (33%) PVf (13%) PV (approx.)

1 23149.8 7639 0.88496 6761

2 39673.8 13092 0.78315 10253

3 28333.8 9350 0.69305 6480

4 20233.8 6677 0.61332 4095

5 14466.6 4774 0.54276 2591

6 14450.4 4769 0.48032 2291

7 14466.6 4774 0.42506 1902

8 7225.2 2384 0.37616 897

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Total present value of incremental tax savings due to depriciation = 35269