Problem 16-52 Net Present Value; Internal Rate of Return; Payback; Sensitivity Analysis; Taxes (Sections 2, 3) (LO 16-3, 16-4, 16-6, 16-8)

The management of Tri-County Air Taxi, Inc., is considering the replacement of an old machine used in its helicopter repair facility. It is fully depreciated but it can be used by the corporation through 20x5. If management decides to replace the old machine, James Transportation Company has offered to purchase it for $70,000 on the replacement date. The old machine would have no salvage value in 20x5. If the replacement occurs, a new machine would be acquired from Hillcrest Industries on December 31, 20x1. The purchase price of $1,300,000 for the new machine would be paid in cash at the time of replacement. Due to the increased efficiency of the new machine, estimated annual cash savings of $410,000 would be generated through 20x5, the end of its expected useful life. The new machine is not expected to have any salvage value at the end of 20x5. Tri-Countys management requires all investments to earn a 12 percent after-tax return. The companys tax rate is 30 percent. The new machine would be classified as three-year property for MACRS purposes.

Use Appendix A and Exhibit 16-9. for your reference. (Use appropriate factor(s) from the tables provided.)

Required:

1. Compute the net present value of the machine replacement investment.

3. Compute the payback period for the replacement of the machine.

4. How much would the salvage value of the new machine have to be on December 31, 20x5, in order to turn the machine replacement into an acceptable investment?