Question

Calligraphy Pens is deciding when to replace its old machine. The machine's current salvage value is $2,500,000. Its current book value is $1,525,000. If not sold, the old machine will require maintenance costs of $655,000 at the end of the year for the next five years. Depreciation on the old machine is $305,000 per year. At the end of five years, it will have a salvage value of $100,000 and a book value of $0. A replacement machine costs $4,100,000 now and requires maintenance costs of $325,000 at the end of each year during its economic life of five years. At the end of the five years, the new machine will have a salvage value of $690,000. It will be fully depreciated by the straight-line method. In five years, a replacement machine will cost $3,100,000. The company will need to purchase this machine regardless of what choice it makes today. The corporate tax rate is 24 percent and the appropriate discount rate is 9 percent. The company is assumed to earn sufficient revenues to generate tax shields from depreciation. Calculate the NPV for the new and old machines.

Answer 1

Use spreadsheet for the ease in computations. Enter values and formulas in the spreadsheet as shown in the image below.

The obtained result is provided below.