Replace or not replace

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noseykibitzer

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This is a question with some teeth...company is deciding to replace or not.

Company Info
Tax Rate = 40%
WACC = 13%

New Machine Cost = $80,000
Salvage Value end of 5 years = $15,000
Shipping Cost = $5,000
Installation Cost = $5,000
Depreciation Schedule = MACR's in years 1 thru 5, 1 - 14%, 2 - 25%, 3 - 17%, 4 - 13%, 5 - 9%
Purchase will initially increase current assets by $20,000 and increase liabilities $25,000
Impact on Operating CF per year 1 thru 5 (includes depreciation and taxes) = $16,800

Old Machine
Current Value = $30,000
Book Value = $13,000

Which is most correct?
A) not replace the old machine with a new one b/c the new one will decrease the firm's value by $5,370
B) replace the old machine with the new machine b/c the new one will add $10,316 to the firm's value
C) not replace the old machine with the new machine b/c the new one will decrease the firm's value by $3,132
D) replace the old machine with the new machine b/c the new one will add $3,760 to the firm's value
 
data regarding old machine is insufficient
it only gives
Current Value = $30,000
Book Value = $13,000
what method of depreciation is used for old asset ?
 
I ran across a bunch of questions like this that got tricky regarding the Current Value and the RBV...if there is no number given for "Value" then use the Salvage Value to be conservative. I had initally used the RBV as the inflow for the old machine because it is more conservative.

The Initial Outlay = -61,800

New Machine Cost = 80,000 + 5,000 + 5,000 = -90,000
Sale of Old Machine = +30,000
Tax on Sale of Old Machine = (30,000 - 13,000) = 17,000 x .40 = -6,800
Change in WC = 20,000-25,000 = -5,000 decrease in WC is a source. So this is added to the inital outlay (I guess the way to figure is the increase on the right side of the BS)

Incremental CF - 1 thru 4 = 16,800

RBV for new machine = 90,000 x .22 = 19,800
Taxable Loss = 15,000 - 19,800 = 4,800 x .40 = 1,920 tax credit
Terminal CF = 16,800 + 15,000+1,920-5,000 = 28, 720

Answer is D
 
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