Question

PLEASE DO NOT USE EXCEL, as we cannot use excel on our test.

The Wagner Company currently uses an injection-molding machine that was purchased 2 years ago. This machine is being depreciated on a straight-line basis, and it has 6-years of remaining life. Its current book value is $2,100, and it can be sold for $2,500 at this time. Thus, the annual depreciation expense is $350 [($2,100/6) = $350 per year]. If the old machine is not replaced, it can be sold for $500 at the end of its useful life. Wagner is offered a replacement machine that has a cost of $8,000, an estimated useful life of 6 years, and an estimated salvage value of $800. This machine falls into the MACRS 5-year class, so the applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. The replacement machine would permit an output expansion, so sales would rise by $2,000 per year. Even so, the new machine's much greater efficiency would reduce operating expenses by $3,000 per year. The new machine would require that inventories be increased by $4,000, but accounts payable would simultaneously increase by $1,000. Wagner's marginal federal-plus-state tax rate is 40%, and its WACC is 15%. Should The Wagner Company replace the old machine? Justify your answer.

Answer 1