Suppose you are thinking to replace an old machine with a new one for your business. The old machine cost you $100,000, and the new one costs $150,000. The new machine will be depreciated on a three-year MACRS basis. The new machine has a 5-year life and a salvage value of zero at the end of this period. The old machine was purchased 5 years ago, and it is being depreciated at the rate of $9,000 per year. Its book value is $55,000, and its salvage value today is $65,000. You estimate that you will be able to sell the old machine for $10,000 in 5 years, if you decide to not replace it. The new machine will save you $50,000 per year. The tax rate is 40%, and the required rate of return is 10%. Based on the NPV and IRR investment criteria, should you replace the old machine? Should the cost of the old machine be included in your decision? Why or why not?

Old machine data Initial cost Annual depreciation Purchased Book value Salvage value today Salvage value in 5 years $100,000 $9,000 5 years ago $55,000 $65.000 $10,000 New machine data $150,000 Initial cost 3yr MACRS 33.33% 7.41% 44.44% 14.82% 5-year life Salvage value in 5 years $0 $50,000 Cost savings per year Required return 0.1 Tax rate Year 2 Year 1 Year 3 50,000.00 s 50,000.00 s 50,000.00 S 50,000.00 s 50,000.00 Cost Savings Depreciation New Is 9,000.00 s 9,000.00 s 9,000.00 s 9,000.00 s 9,000.00 Depreciation Old Year Year o Year 1 Year 4 Year 2 Year 3 Change in NWC Year 5