Replacement analysis The Dauten toy corporation uses an injection molding machin
ID: 2665869 • Letter: R
Question
Replacement analysisThe Dauten toy corporation 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 $2,100/6= $350 per year. If the machine is not replaced, it can be sold for $500 at the end of its useful life.
Dauten 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 $1,000 per year. Even so, the new machine's greater efficiency would cause operating expense to decline by $1,500 per year. The new machine would require that inventories be increased by $2,000 but accounts payable would simultaneously increase by $500. Dauten's marginal federal-plus-state tax rate is 40% and its WACC is 15%. Should the company replace the old machine?
Explanation / Answer
The NPV is positive,hence Replace the machine .
Rate
Amount
Net Income
Cash Flows Rate
PV
1
20%
1440
1500
2940 15%
2,556.52 2
32%
2304
1500
3804 15%
2,876.37 3
19%
1368
1500
2868 15%
1,885.76 4
12%
864
1500
2364 15%
1,351.62 5
11%
792
1500
2292 15%
1,139.53 6
6%
432
1500
1932 15%
835.26 Present Value
10,645.06 Less: Investment in Equipment
8,000.00 Increase in Working Capital
1,500.00 NPV
1,145.06