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The Dauten Toy Corporation currently uses an injection molding machine that was purchased 2 years ago. This machine is being depreciated on a straightline basis, and it has 6 years of remaining life. Its current book value is $2,100, and it can be sold for $2,500 at this time. Thus, the annual depreciation expense is $2,100/6 = $350 per year. If the old machine is not replaced, it can be sold for $500 at the end of its useful life.
Dauten is offered a replacement machine which has a cost of $8,000, an estimated useful life of 6 years, and an estimated salvage value of $800. This machine falls into the MACRS 5year class so the applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. the replacement machine would permit an output expansion, so sales would rise by $1,000 per year; even so, the new machine's much greater efficiency would cause operating expenses to decline by $1,500 per year. the new machine would require that inventories be increased by $2,000, but accounts payable would simultaneously increase by $500. Dauten's marginal federalplusstate tax rate is 40%, and its WACC is 15%. Should it replace the old machine?
Here we have the calculation to find the solution.










Net cash flow at t = 0: 

















Purchase price 








Sale of old machine 








Tax on sale of old machine 







Change in net working capital 







Total investment 


















Annual cash inflows: 

















Sales increase 








Cost decrease 








Pretax revenue increase 







Tax benefit 








Aftertax revenue increase 

















Depreciation: 











Year 1 
Year 2 
Year 3 
Year 4 



New 









Old 









Change 



















Depreciation tax savings 



























Calculate NPV: 





















Year 0 
Year 1 
Year 2 
Year 3 
Year 4 
Year 5 
Year 6 
Net investment 








Aftertax revenue increase 







Depreciation tax savings 







Working capital recovery 







Salvage value of new machine 







Tax on salvage value 







Opportunity cost of old machine 







Project cash flows 


















NPV = 









Replace old machine (Yes/No)? 






