Torreo Coffee Roaster is considering replacing one of its existing machines with a new one. Torreo bought the old one 4 years ago for $87,500. It is being depreciated on a SL basis over a 14-year life. The machine could be sold today 1/1/2000, for $20,000.

The new machine costs $95,000. It has a 10-year depreciable life with salvage value of $13,000 in real terms. However, based on the tax law, the asset will be depreciated to 0 over 10 years using a SL method.

In 1999 Torreo's current coffee machine accounted for annual revenue of $50,000 and has annual costs of $25,000. The new machine will increase revenue to $65,000 per year (in real terms, that is, in 1999 dollars). The machine will also increase operating costs by $3,000 in real terms.

The nominal discount rate is 14% per annum. The corporate tax rate is 40%. The annual anticipated inflation rate is 5%. All cash flows occur at the end of year. Taxes are also paid at the end of year. Should Torreo replace the old machine with the new one?

Nominal discount rate	14%
Inflation Rate	5%
Real discount rate	8.57%	<-- =(1+B2)/(1+B3)-1
Corporate tax	40%
New machine			Old machine
Machine's cost	95,000		Machine's cost	87,500.00
Life span	10		Life span	14.00
Additional revenue	15,000		# of years since purchase	4.00
Additional costs	3,000
Machine's disposal Value	0
Nominal Depreciation	9,500		Depreciation old machine	6,250.00
Machine real salvage value	13,000		B.V. old machine**
			Market value old machine	20,000