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National Bottling Company is contemplating the replacement of one of its bottling machines with a new, more efficient machine. The old machine had a cost
National Bottling Company is contemplating the replacement of one of its bottling machines with a new, more efficient machine. The old machine had a cost of 1,000,000 and a useful life of ten years. The machine was bought five years ago. The company does not expect to realise any return from scrapping the old machine at the end of ten years, but if it is sold at present to another company in the industry, National Bottling Company would receive 600,000 for it. The new machine has a purchase price of 2,000,000. It has an estimated salvage value of 600,000 and has a useful life of five years. The new machine will have a greater capacity, and annual sales are expected to increase from 1,000,000 to 1,200,000. Operating efficiencies with the new machine will also produce savings of 200,000 a year. Depreciation is on a straight-line basis over a ten-year life span. The cost of capital is 8%, and a 50% tax rate is applicable to both revenue and capital gains. The present value interest factor for an annuity for five years at 8% is 3.993, and the present value interest factor at the end of five years is 0.681. Required: Should the company replace the old machine? Explain the reasoning underpinning your answer. (Hint: use NPV techniques to answer this question.)
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