Assume that laban Company is considering the purchase of a newer, more efficient yogurt-making

machine. If purchased, it would require the new machine on January 2, year 1. laban expects to sell

600,000 gallons of yogurt in each of the next five years at a $2 per gallon selling price.

laban has two options:

(1) continue to operate the old machine purchased four years ago or

(2) sell it and purchase the new machine.

The following information has been prepared to help decide which option is more desirable.

Original cost of machine at acquisition:

old machine $1,600,000

new machine$2,000,000

Useful life from date of acquisition:

old machine 7 years

new machine 5 years

Expected annual cash operating expenses:

variable cost per gallon

$1.20 old machine

$1.00 new machine

total fixed cash costs

$400,000 old machine

$160,000 new machine

depreciation is as follows:

age of equipment (years) tax depreciation rate

1 15%

2 25%

3 20%

4 20%

5 20%

Estimated cash value of machines follows:

old machine new machine

january 2, year 1 $400,000 $ 2,000,000

december 31, year 3 $200,000 $1,000,000

laban is subject to a 40% income tax rate on all income. Assume that tax depreciation is calculated

without regard to salvage value. Use an after-tax discount rate of 10%.