Question

A firm is deciding when to replace its old machine. The old machine’s current aftermarket value is $1.9 million. Its book value is $1.26 million. If not replaced now, the old machine will require operating costs of $511,000 each year. Depreciation on the old machine is $252,000 per year. At the end of its remaining useful life of five years, the old machine will have an aftermarket sale value of $212,000. A new machine costs $2.95 million now and requires operating costs of only $344,000 each year during its life of five years. At the end of the five years, the new machine will have a scrap value of $508,000. If acquired now, the new machine will be fully depreciated using the straight-line method. In five years a new machine will cost $3.5 million. The firm will need to purchase a new machine regardless of what choice it makes today. The tax rate is 21% and the discount rate is 10%. If the timing of the machine replacement will not have any impact on revenues and net working capital levels, should the firm replace the old machine now or after five years?

Answer 1