In: Finance
Replacement Analysis
DeYoung Entertainment Enterprises is considering replacing the latex molding machine it uses to fabricate rubber chickens with a newer, more efficient model. The old machine has a book value of $800,000 and a remaining useful life of 5 years. The current machine would be worn out and worthless in 5 years, but DeYoung can sell it now to a Halloween mask manufacturer for $270,000. The old machine is being depreciated by $160,000 per year, using the straight-line method.
The new machine has a purchase price of $1,190,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $105,000. The applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. Being highly efficient, it is expected to economize on electric power usage, labor, and repair costs, and, most importantly, to reduce the number of defective chickens. In total, an annual savings of $255,000 will be realized if the new machine is installed. The company's marginal tax rate is 35%, and it has a 12% WACC.
Year |
Depreciation Allowance, New |
Depreciation Allowance, Old |
Change in Depreciation |
1 | $ | $ | $ |
2 | $ | $ | $ |
3 | $ | $ | $ |
4 | $ | $ | $ |
5 | $ | $ | $ |
CF1 | $ |
CF2 | $ |
CF3 | $ |
CF4 | $ |
CF5 | $ |
In general, how would each of the following factors affect the
investment decision, and how should each be treated?
(1) The expected life of the existing machine decreases.
(2) The WACC is not constant but is increasing as DeYoung adds more
projects into its capital budget for the year.
The input in the box below will not be graded, but may be reviewed and considered by your instructor.