The Quick Manufacturing Company, a large profitable corporation, is considering the replacement of a production machine tool.

Question:

The Quick Manufacturing Company, a large profitable corporation, is considering the replacement of a production machine tool. A new machine would cost $3700, have a 4-year useful and depreciable life, and have no salvage value. For tax purposes, sum of- years'-digits depreciation would be used. The existing machine tool was purchased 4 years ago at a cost of $4000 and has been depreciated by straight line depreciation assuming an 8-year life and no salvage value. The tool could be sold now to a used equipment dealer for $1000 or be kept in service for another 4 years. It would then have no salvage value. The new machine tool would save about $900 per year in operating costs compared to the existing machine. Assume a 40% combined state and federal tax rate.

(a) Compute the before-tax rate of return on the replacement proposal of installing the new machine rather than keeping the existing machine.

(b) Compute the after-tax rate of return on this replacement proposal.

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