Question

The Dauten Toy Corporation uses an injection molding machine that was purchased prior to the new tax legislation. This machine is being depreciated on a straight-line basis, and it has 6 years of remaining life. Its current book value is $2,400, and it can be sold for $2,600 at this time. Thus, the annual depreciation expense is $2,400/6 = $400 per year. If the old machine is not replaced, it can be sold for $500 at the end of its useful life.

Dauten is offered a replacement machine which has a cost of $9,000, an estimated useful life of 6 years, and an estimated salvage value of $800. The replacement machine is eligible for 100% bonus depreciation at the time of purchase. The replacement machine would permit an output expansion, so sales would rise by $800 per year; even so, the new machine's much greater efficiency would cause operating expenses to decline by $1,000 per year. The new machine would require that inventories be increased by $2,000, but accounts payable would simultaneously increase by $800. Dauten's marginal federal-plus-state tax rate is 25%, and its WACC is 11%.

- What is the NPV of the incremental cash flow stream? Negative value, if any, should be indicated by a minus sign. Round your answer to the nearest cent. $

- Should the company replace the old machine?

Answer 1

Step 4:
Calculation of Incremental Salvage value
Particulars	Year 6
Replacement Machine Salvage Value	800
Old Machine salvage Value	-500
Net Salvage Value	300

Step 6:

Calculation of NPV of the Incremental Cash Flows

NPV of the Incremental Cash Flows is $477.06