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The Sumitomo Chemical Corporation is considering replacing a 5-year-old machine that originally cost $50,000 and can be sold for $60,000. This machine is totally depreciated.

The Sumitomo Chemical Corporation is considering replacing a 5-year-old machine that originally cost $50,000 and can be sold for $60,000. This machine is totally depreciated. The replacement machine would cost $125,000, and have a 5-year expected life over which it would be depreciated down using the straight-line method and have no salvage value at the end of five years.

The new machine would produce savings before depreciation and taxes of $45,000 per year. Assuming a 34 percent marginal tax rate and a required return of 10%, calculate:

(a) The internal rate of return and the net present value

(b) Assume now that the machine to be replaced is not totally depreciated. This machine presently has a book value of $25,000 and is being currently depreciated using the straight-line method down to a terminal value of zero over the next five years, generating depreciation of $5,000 per year. If the rest of the variables involved in the problem do not vary, what is now the net present value of substituting the machine?

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