Question 1A

A company intends to upgrade its machine for a 10-year project, which just passed its sixth year. The new machine is of higher precision which is estimated to reduce defect costs of $80,000 per year and warranty claims by customers by $100,000 per year for the remaining life of the project. The applicable corporate tax rate is 17% and the cost of capital for similar risk projects is 15 percent. More details on the existing and new machines are available:

	Existing Machine	New Machine
Depreciable sum	$1,000,000	$700,000
Depreciation method	Straight line	Straight line
Current salvage value	$500,000	--
Salvage value in 4 years time	$ 0	$ 100,000
Maintenance fee	$ 0	Year 2: $40,000

Required:

1. Compute the incremental net present value of for the new machine.

2. Should the new machine be purchased?