BL Company currently sells product A$.$ The company has signed a five$-$year exclusive contract to sell $1,000,000$ units per year of product A at a locked in sales price of $$3\mathrm{.}80$ per unit. The company manufactures the product with a machine that it purchased $3$ years ago at a cost of $$700,000$ and has a book value of $$450,000.$ The machine is expected to last another $5$ years, after which it will have no salvage value. Last year, the production variable costs per unit were as follows:

Direct materials $ $1\mathrm{.}20$

Direct labour $0\mathrm{.}70$

Variable overhead $0\mathrm{.}50$

Total variable cost per unit $$2\mathrm{.}40$

The company president is considering replacing the old machine with a new one that would cost $$800,000$ and will take the old machine as a trade in for $$230,000.$ The new machine is expected to last $5$ years. At the end of that period, the salvage value will be $$350,000.$ The president expects to save $5\%$ of the company$$s total variable costs with the new machine.

Instructions

Assume that the company's cost of capital is $12\%,$ income tax rate is $40\%$ and depreciation is calculating on a straight$-$line rate for both accounting and tax purposes, determine if the company should replace the old machine with the new one? Calculate the Net Present Value of the decision. Show all your calculations for part marks. I also recommend that your solution identify the incremental numbers and separate the income impact from the capital outlays net of tax shield.