Pilot Plus Pens is deciding when to replace its old machine. The machines curren
ID: 2382738 • Letter: P
Question
Pilot Plus Pens is deciding when to replace its old machine. The machines current salvage value is $2.26 million. Its current book value is $1.46 million. If not sold, the old machine will require maintenance costs of $851,000 at the end of the year for the next five years. Depreciation on the old machine is $292,000 per year. At the end of five years, it will have a salvage value of $126,000 and a book value of $0. A replacement machine costs $4.36 million now and requires maintenance costs of $336,000 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 $806,000. It will be fully depreciated by the straight-line method. In five years a replacement machine will cost $3,260,000. Pilot will need to purchase this machine regardless of what choice it makes today. The corporate tax rate is 40 percent and the appropriate discount rate is 7 percent. The company is assumed to earn sufficient revenues to generate tax shields from depreciation.
Calculate the NPV for new and old machines.
Explanation / Answer
Year Total present Value 0 1 2 3 4 5 discount factor @ 7 % 0.93 0.87 0.82 0.76 0.71 Value in $ Old machine continued Current salvage value (initial outlay) (2,260,000) (2,260,000) Maintenance (851,000) (851,000) (851,000) (851,000) (851,000) PV of maintenance cost (3,488,933) (795,327) (743,231) (694,694) (649,123) (606,557) Depreciation 292,000 292,000 292,000 292,000 292,000 Tax saving on depreciation@40% 116,800 116,800 116,800 116,800 116,800 PV of Tax saving 478,857 109,159 102,009 95,347 89,092 83,250 Salvage value 126,000 PV of salvage value 89,808 89,808 NPV of old machine (5,180,268) Repalcement machine Initial outlay (4,360,000) (4,360,000) Maintenance (336,000) (336,000) (336,000) (336,000) (336,000) PV of maintenance cost (1,377,534) (314,019) (293,450) (274,286) (256,293) (239,487) Depreciation 710,800 710,800 710,800 710,800 710,800 Tax saving on depreciation@40% 284,320 284,320 284,320 284,320 284,320 PV of Tax saving 1,165,656 265,720 248,314 232,098 216,873 202,651 Salvage value 806,000 PV of salvage value 574,483 574,483 NPV of new machine (3,997,395) Replacement M/C cost after (3,260,000) 5 years PV of machine cost (2,323,592) NPV of machine to be purchased after 5 years (2,323,592)