Pilot Plus Pens is deciding when to replace its old machine. the machines curren
ID: 2427249 • Letter: P
Question
Pilot Plus Pens is deciding when to replace its old machine. the machines current salvage value is $2.4 million. Its current book value is $1.6 million. If not sold, the old machine will require maintenance costs of $865,000 at the end of the year for the next five years. Depreciation on the old machine is $320,000 per year. At the end of five years, it will have a salvage value of $140,000 and a book value of $0. A replacement machine costs $4.5 million now and requires maintenance costs of $350,000 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 $820,000. It will be fully depreciated by the straight-line method. In five years a replacement machine will cost $3,400,000. Pilot will need to purchase this machine regardless of what choice it makes today. the corporate tax rate is 34 percent and the appropriate discount rate is 8 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 (e.g. 1, 234,567). Do not round intermediate calculations and round your final answers to 2 decimal places (e.g., 32.16). A negative sign should be used for negative answers.)Explanation / Answer
Old Machine New Machine Salvage Value 2400000 Current Book Value 1600000 Maintenance Cost 865000 350000 Depreciation 320000 0 After 5 Years Salvage Value 140000 820000 After 5 Year Book Value 0 Replacement Cost 4500000 3400000 Corporate Tax - 34% Discount -8 % Buy New machine Keep Old Machine Differential Initial Cash outlay Buy New Machine -3400000 0 -3400000 Sell (buy) Old machine -1600000 1600000 Tax on sale 272000 -272000 Total -3400000 -1328000 -2072000 By Keeping the old machine we are losing the oppourtunity cost of selling at 2.4 Million and getting the benefit of not paying capital gain tax Maintenance Cost -350000 -865000 515000 Depreication -680000 -320000 -360000 EBT -1030000 -1185000 155000 Taxes 34% 350200 402900 -52700 Net Income -679800 -782100 102300 Add Back : Depreciation 680000 320000 360000 OCF 200 -462100 462300 After Tax salvage Value 0 Sell Machine 820000 140000 680000 Taxes -278800 -47600 -231200 Lost Sale of Old 0 0 0 Taxes on sale of old 0 0 0 Total 541200 92400 448800 NPV -477520 -829040 351520