Macintosh Printing Inc. purchased a
$16 comma 00016,000
printing machine
twotwo
years ago. The company expected this machine to have a
sixsix-year
life and a salvage value of
$5 comma 0005,000.
Unfortunately, the company spent
$5 comma 0005,000
last year on repairs, and current operating costs are now running at the rate of
$7 comma 0007,000
per year. Furthermore, the anticipated salvage value has now been reduced to
$2 comma 5002,500
at the end of the printer's remaining useful life. In addition, the company has found that the current machine has a book value of
$12 comma 13612,136
and a market value of
$8 comma 0008,000
today. Suppose that the company has been offered the opportunity to purchase another printing machine for
$16 comma 00016,000.
Over its
fourfour-year
useful life, the machine will reduce labor and raw-materials usage sufficiently to cut operating costs from
$7 comma 0007,000
to
$6 comma 0006,000.
This reduction in costs will allow after-tax profits to rise by
$1 comma 0001,000
per year. It is estimated that the new machine can be sold for
$5 comma 5005,500
at the end of year
44.
If the new machine were purchased, the old machine would be sold to another company rather than be traded in for the new machine. Suppose that the firm will need either machine (old or new) for only
fourfour
years and that it does not expect a new, superior machine to become available on the market during the required service period. Assuming that the firm's interest rate is
14%,
decide whether replacement is justified now.