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

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

In 1999, Torreo's current coffee machine generated 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 year. The corporate tax rate is 40%. The anticipated annual inflation rate is 5%. All cash flows occur at the end of the year. Taxes are also paid at the end of the year. Should Torreo replace the old machine with the new one?

nominal discount rate	14%
Rate of inflation	5%
actual discount rate	?
corporate tax	40%
new machine			old machine
machine cost	95,000		machine cost	87,500.00
Life expectancy	10		Life expectancy	14.00
additional income	15,000		# of years since purchase	4.00
additional costs	3,000
Disposal value of the machine	0
face depreciation	9,500		old machine depreciation	6,250.00
actual salvage value of the machine	13,000		old machine BV**	?
			old market value machine	20,000