Pilot Plus Pens is deciding when to replace its old machine. The machines curren
ID: 2383190 • 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. (Enter your answers in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))
Calculate the NPV for new and old machines. (Enter your answers in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your final answers to 2 decimal places. (e.g., 32.16))
Explanation / Answer
OLD MACHINE
126000
· Since it is mention that new machine has to be purchased regardless what decision we made today so it is immaterial to include it in the calculation.
IF THE OLD MACHINE SOLD TODAY
Cash Flow = (2.26 - 1.46) * (1-0.40) = $0.48 million
IF THE OLD MACHINE IS SOLD AFTER 5 YEARS
Annual Cash Flow = ( -851,000 + -292,000) * (1-0.40) + 126,000 = -$209400 outflow
Present value of outflow = -4360000 * PVAF(7%, 5years) =-$3194934.72or 3.19 millions
Salvage value = 806000* (1-0.40) = 483600
Present value of salvage value = 483600 * PVF(7%, 5years) = $ 2649684.05 or 2.64million
Net Cash flow = -$3.19 million + $2.64 million = -$0.55 million
DECISION:
Since, there is loss in keeping the machine for 5 years, thus, old machine should be sold today.
current market value 2260000 current book value 1460000 annual 845000 depreciation 292000 salvage value in 5 years126000