Question

Your company is considering replacing an old machine with a new machine. The new machine will cost $1 million, will last for 5 years, and will have a salvage value of $200,000 at the end of five years. If the company replaces the old machine with the new machine, pre-tax operating costs will go down by $300,000 per year. The cost of the new machine ($1 million) will be depreciated over the 5 years life of the project using the straight line depreciation method to the $200,000 salvage value (i.e., the annual depreciation is $160,000). The old machine was purchased at a price of $800,000 five years ago, and it still has five years of useful life. It can be sold today for $200,000. However, after five years, the salvage value of the old machine will be zero. The cost of the old machine has also been depreciated using the straight line depreciation to the $0 salvage value (i.e. the annual depreciation is $80,000). The company's tax rate is 40%. The WACC for the project is 6.4%. What is the NPV of replacing the old machine with the new machine, and should the firm make the replacement?

Answer 1

Since the NPV is psitive and hence the firm should make the replacement.

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