Replacement of a machine, income taxes, sensitivity. (CMA, adapted) The WRL Company operates a snack food centre at the Hartsfield Airport. On January 2, 2005, WRL purchased a special cookie-cutting machine, which has been used for three years.

WRL is considering purchasing a newer, more efficient machine. If purchased, the new machine would be acquired today on January 2, 2008. WRL expects to sell 300,000 cookies in each of the next four years. The selling price of each cookie is expected to average $0.60.

WRL has two options: (1) continue to operate the old machine or (2) sell the old machine and purchase the new machine. The seller of the new machine offered no tradein.

The following information has been assembled to help management decide which option is more desirable:
Old Machine New Machine Initial machine investment Terminal disposal price at the end of useful life assumed for amortization purposes Useful life from date of acquisition Expected annual cash operating costs:
Variable cost per cookie Total fixed costs Amortization method used for accounting purposes Estimated disposal prices of machines:
January 2, 2008 December 31,2011 Capital cost allowance rate (declining balance)
$96,000 $12,000 7 years $0.24 $18,000 8traight-line $48,000 $8,400 25%
$144,000 $24,000 4 years $0,168 $16,800 $traight-line $144,000 $24,000 25%
WRL has a 40% income tax rate and an after-tax required rate ofreturn of 16%.
Required 1. Use the net present value method to determine whether WRL should retain the old machine or acquire the new machine.
2. How much more or less would the recurring after-tax variable cash operating savings have to be for WRL to exactly earn the 16% after-tax required rate ofreturn? Assume all other data about the investment does not change.
3. Assume that the financial differences between the net present values ofthe two options are so slight that WRL is indifferent between the two proposals. Identify and discuss the nonfinancial and qualitative factors that WRL should consider.