Problem:
The new machine will be depreciated using the straightline method over its useful life. The new machine will replace an existing machine that was bought 10 years ago for $600,000. It had an estimated useful life of 15 years and is being depreciated using the straightline method over its life. The machine could be sold for $150,000 today.
If the new machine was implemented, the company estimates that revenues will increase by the following amounts each year:
Years 1 - 3 $300,000
Years 4 - 5 $250,000
Cash costs are also expected to increase by an additional $60,000 each year.
The company has an after-tax discount rate of 9 percent and is subject to the company tax rate of 30 percent. Assuming Levelhead Company is not integrated with the dividend imputation system, should the firm purchase the new machine?
| Salvage of Old Machine |
$150,000 |
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| Installation costs |
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$10,000 |
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| Freight costs |
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$10,000 |
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| Tax savings from salvage Old Machine |
$15,000 |
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| Tax savings from depreciation differential |
$30,000 |
$30,000 |
$30,000 |
$30,000 |
$30,000 |
| Inflow |
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|
$300,000 |
$300,000 |
$300,000 |
$250,000 |
$250,000 |
| Increase Cash Cost |
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|
($60,000) |
($60,000) |
($60,000) |
($60,000) |
($60,000) |
| Increase in Tax Payable |
|
($72,000) |
($72,000) |
($72,000) |
($57,000) |
($57,000) |
| Sale Price |
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$350,000 |
| Net Cash Flow |
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($815,000) |
$198,000 |
$198,000 |
$198,000 |
$163,000 |
$513,000 |
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|
|
1.09 |
1.1881 |
1.295029 |
1.411582 |
1.538624 |
| PV Cash Flow |
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($815,000) |
$181,651 |
$166,653 |
$152,892 |
$115,473 |
$333,415 |
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| Reuired Rate Of Return |
9.00% |
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| NPV |
135,084 |
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| IRR |
? |
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| The company should purchase the automated machine as the NPV > 0 |
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