Existing Machine

The existing machine was a Matrix $750.$ The Matrix had been purchased secondhand when it was five years old. Davidson was particularly

concerned with staff safety and was reluctant to allow other staff members to use this machine because this particular model was known to be very sensitive to the angle of the timber and would kick back severely if the lumber was not correctly positioned. Davidson had not experienced this particular problem since owning the machine.

A competitor had offered $$35,000$ cash for the machine, an amount that represented its current book value. If Davidson opted to keep the machine, Magic would continue to claim depreciation of $$6,000$ per year for each of the next five years, at which point the machine would be unserviceable and would be sold for $$5,000$ as scrap. If Davidson elected to keep and repair the old machine, it would require $$28,000$ to be spent immediately and $$7,000$ in regular maintenance in each of the next five years. In Year $3,$ the machine would require another investment of $$4,000$ for a larger scheduled service.

New Machine

The new machine under consideration was a Delta A$390,$ which offered an increase in capacity of $40$ per cent. This capacity was probably in excess of Magic's needs, although the business would make some use of it$.$ Also, the new machine allowed the possibility of obtaining some custom work for a specialist woodcrafter.

The new machine cost $$145,000,$ and the tax office allowed straight line depreciation of $10$ per cent per annum. After five years, Magic would sell the Delta for $$70,000.$ Given that the company selling the machine to Magic operated in a very competitive market, it was willing to negotiate on the terms of a maintenance plan. The seller offered fixed pricing starting at $$2,000$ in the first year, increasing by $$1,000$ per year $($payable at year end$).$ To fund the purchase, Magic's bank offered a $6$ per cent per annum loan to be repaid as interest$-$only payments for five years, with the full principal repayable at the end of the loan period.

Given the technological advancements of the Delta over the Matrix, Davidson expected that he could achieve significant savings in both labour and electricity costs. For labour, in the first year, Davidson forecasted a $10$ per cent cost reduction $($the existing rate was $$30$ per hour$),$ based on a $35-$ hour week in a $50-$week year. This labour saving would then increase by a fixed $$250$ each year.

For electricity, in the first year, the saving was expected to be $10$ per cent as well. Electricity costs averaged $$5\mathrm{.}625$ per hour, $24$ hours a day, seven days a week, in a $50-$week year. This electricity saving would then increase by a fixed $$75$ each year.

Using NPV analysis, should Magic Timber and Steel $($Magic$)$ purchase the new Delta finishing machine?

You may assume discount rate as $10\%$ and tax rate as $30\%.$