Question

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Let say that juda   Company is considering the purchase of a newer, more efficient yogurt-making machine. If purchased, it would require the new machine on January 2, year 1. juda   expects to sell 600,000 gallons of milk in each of the next five years at a $2 per gallon selling price.

juda   has two options:

(1) continue to operate the old machine purchased four years ago or

(2) sell it and purchase the new machine.

The following information has been prepared to help decide which option is more desirable.

Old Machine New Machine Original cost of machine at acquisition $ 1,600,000 $ 2,000,000 Useful life from date of acquisition 7 years 5 years Expected annual cash operating expenses:    Variable cost per gallon $1.20 $1.00    Total fixed cash costs $ 400,000 $ 160,000 Estimated cash value of machines follows: Old Machine New Machine January 2, Year 1 $ 400,000 $ 2,000,000 December 31, Year 3 $200,000 0 December 31, Year 5    0                 $500,000

juda   is subject to a 40% income tax rate on all income. Assume the company uses the straight-line method for books and tax purposes. Assume that tax depreciation is calculated without regard to salvage value. Use an after-tax discount rate of 10%.

Answer 1

Based on the given data, pls find below workings;

Have made certain assumptions required:

- Since it is mentioned that the life of the old machine is only 7 years and already fours years have been used, it is assumed that the balance life for serving is only 3 years; Given this assumption, considered cash flows only for next three years; There shall be no initial outflow as the machine is already existing and no upgrading costs etc are spendt as part of initial outlfow; Depreciation (straight line) is considered for the left out 3 years period;

Based on the above, and based on the below workings, it seems continuing with the old machine itself is more feasible than going for investment in to new machine at this point of time;