Finance: finance – #278


Question: Question 4: It is early January 2005. Your company is currently operating a machine you purchased 4 years ago for $1.2m. The machine, which is subject to a 6-year straight line depreciation schedule, has been operating for the past 4 years and will operate for another 6, including the current year. This machine will have a salvage value of $400k. The machine requires periodic maintenance. You still have a service contract with the supplier at the annual cost of $10k; this contract expires at the end of next year, after which you expect to pay an annual cost of $50k for servicing. You are considering the purchase of a new machine to be put in use immediately. It costs $600k, it has the same production capacity as the old one, and it has useful life of 6 years total (including the current year). The new machine is subject to a 4-year straight-line depreciation schedule. At the end of its life it will have no salvage value. The cost of servicing the new machine is 30k per year. The new machine is more efficient and allows you to save $20k a year in production costs. The current resale value of the old machine is $500k. The corporate tax rate is 40%, there is no inflation, and the appropriate discount rate is 14%. Should you replace the machine?

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