Advance financial management

Font CAPITAL BUDGETING PROBLEMS I 1. The Gadget Co. is considering the replacement of one of its gadget making machmes with a newer and more efficient one. The old machine has a current book value of $500,000 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 $300,000. The old machine is being depreciated on a straight-line basis at the rate of $250,000 per year. The new gadget maker has a purchase price of $1,300,000 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 30%, both on capital gains or losses and ordinary income, and the cost of capital is 15% Should Gadget Co. replace its old machine? 0 1 2 Capital Spending Salvage - Old ARevi-t) 0 0 1 2 NI Capital Spending Salvage - Old I ARev(1-1) AExp(1-1) ADepreciation tax shield FCF PV NPV