Making Capital Investment Decisions

Isaac, Inc. is thinking about purchasing a new machine to replace an old one. The new
machine would cost $300,000. The machine will have a life of 6 years and will be
depreciated using the 5-Year MACRS table (page 275 in book). The machine has a
salvage value $35,000 at the end of its life and will be sold then. This machine is
expected to produce cost savings of $20,000 per year over the old machine. The old
machine had a twelve year life and was purchased for $500,000 6 years ago with a
salvage value of $8,000. It is depreciated using the straight-line method. The machine
can be sold right now for $260,000 and can be sold for $8,000 in 6 years. It will take
$5,000 in net working capital to maintain the new machine. The company has a required
return of 10% and is in the 40% tax bracket. Calculate the NPV of the project and
determine if the company should replace the old machine with the new one.
Year
Cost Savings
New Deprec.
Old Deprec.
Incremental
EBIT
Taxes
Net Income

1
20,000
60,000
41,000
19,000
1,000
400
600

2
20,000
96,000
41,000
55,000
-35,000
-14,000
-21,000

3
20,000
57,600
41,000
16,600
3,400
1,360
2,040

4
20,000
34,560
41,000
-6,440
26,440
10,576
15,864

5
20,000
34,560
41,000
-6,440
26,440
10,576
15,864

6
20,000
17,280
41,000
-23,720
43,720
17,488
26,232

OCF

19,600

34,000

18,640

9,424

9,424

2,512

Year
OCF
Change in
NWC
Capital
Investment
Net CF

1
19,600

2
34,000

3
18,640

4
9,424

5
9,424

6
2,512
5,000

-5,000
-300,000
257,600

-47,400

19,600

34,000

18,640

9,424

9,424

-8,000
21,000
20,512

Depreciation Old = (500,000 8,000) / 12 = 41,000

Depreciation New = Year 1) 300,000 x .20 = 60,000 2) 300,000 x .32 = 96,000
3) 300,000 x .192 = 57,600 4&5) 300,000 x .1152 = 34,560 6) 300,000 x .0576 = 17,280
After Tax Salvage Value Old Year 1 = 260,000 - .40(260,000 254,000) = 257,600
After Tax Salvage Value Old Year 6 (Opportunity Lost) = 8,000 - .40(8,000 8,000)
After Tax Salvage Value New = 35,000 - .40(35,000 0) = 21,000
NPV = 36,388.63 Accept Project