Eastern Educational Services is considering the following proposal to sell its teaching machine and purchase a new, improved machine. The following data are presented by the department head:

Additional information:
1. The company expects to produce 10,000 units a year selling at $10 each with either machine.
2. The company’s tax rate is 40 percent on all income and expenses.
3. All annual income and expenses are assumed to occur at year-end.
4. The company’s cost of capital is 12 percent after taxes.
5. The firm is located in a European country where capital gains are taxed at 40 percent.
Capital gains are computed as the difference between the sales price and book value (original cost less accumulated depreciation).
Required:

a. Present a financial analysis in which you evaluate the proposal. A clear presentation is important.

b. Would you be more likely, less likely, or equally likely to recommend the purchase of the new machine given the following:
(i) The company’s discount rate is increased.
(ii) The new machine can be depreciated by the double-declining-balance method.

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Purchase date Original cost, installed Salvage value Useful life Depreciation method Present market value, net of disposal costs (book value $52,000) Property taxes and insurance Annual maintenance costs and otherwise fixed costs (other than depreciation) Variable production costs per unit Present Machine 1/1/99 $100,000 $20,000 10 years Straight line $60,000 5% of original cost $10,000 $5 New Machine 1/1/05 $140,000 $40,000 4 years Straight line 5% of original cost $4.000 $2