6. The Gadget Co. is considering the replacement of one of its gadget making machines with a newer and more efficient one. The old machine has a current book value of $1,200,000 and a remaining useful life of 2 years. The firm expects the old machine to be worthless in 2 years, or it can sell it now to another of the many gadget makers in the economy for $500,000. The old machine is being depreciated on a straight-line basis at the rate of $600,000 per year. The new gadget maker has a purchase price of $1,400,000, a two-year life, no estimated salvage, and is being depreciated on a straight line basis. The new gadget maker can produce brighter and more durable gadgets. Consequently, the sales price can be increased from $1.30 to $2.00, and the quantity sold can be increased from 300,000 units to 525,000 units per year. The new machine requires a computer programmer however, at a cost of $90,000 per year. The company last year spent $90,000 researching the new gadget maker. The tax rate is 25%, both on capital gains or losses and ordinary income, and the cost of capital is 15%.

A. Should Gadget Co. replace its old machine?

B. How much would revenue need to change to break even?

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Capital Spending
Salvage - Old
Rev(1 t)
Exp(1 t)
Depreciation tax shield
FCF
PV
NPV