ANSWER FOR B .....(A IS CORRECT)

A company owns a packaging machine, which was purchased three years ago for $56,000. It has a remaining useful life of five years, providing that it has a major overhaul at the end of two more years of life, at a cost of $10,000 fully deductible in that year for income tax purposes. Its

Disposal value now is $20,000; in five years, its disposal value will be $8,000. The cash operating costs of this machine are expected to continue at $40,000 annually.

A manufacturer has offered a substitute machine for $51,000 in cash. The new machine will reduce annual cash operating costs by $10,000, will not require any overhauls, will have a useful life of five years, and will have a disposal value of $3,000.

The company uses straight line depreciation for tax purposes, with no provision for residual value.

Required:

Assume that the minimum desired rate of return, after taxes, is 10 percent. Using the net present value technique, show whether the new machine should be purchased. Assume that income tax rates are 35 percent on ordinary income. Assume that all taxes are paid in the same year in which the taxable income is earned. Also, assume that the zero residual used for tax purposes will not be challenged by the Internal Revenue Service. ANSWER FOR B. ANSWER FOR B

			Amount	Year	End of ith year	PV
A.
Purchase New Machine
Purchase of New Machine			($51,000.00)			($51,000.00)
Annual depreciation expense		$10,200.00
Tax savings		$3,570.00		5		$13,533.11
Cost of old machine		$ 56,000.00
Accumulated depreciation		$ 33,600.00
Book value		$ 22,400.00
Disposal of Old Machine		$20,000.00				$ 20,000.00
Loss on disposal of old machine		$ 2,400.00
Tax savings		$ 840.00			3	$631.10
Annual operating expense		$30,000.00
Tax savings		$10,500.00
Annual operating expense after tax		$19,500.00		5		($73,920.34)
Disposal of new machine		$3,000.00			5
Tax		$1,050.00
After tax cash inflow		$1,950.00			5	$1,210.80
PV of net cash outflows						($89,545.33)
B.
Keep Old Machine
Disposal of Old Machine
Annual Operating Cost
Overhaul
PV of net cash outflows
Difference in favor of purchasing new machine