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Edwards manufacturing company is considering replacing one machine with another the old machine was purchased 3years...

Edwards manufacturing company is considering replacing one machine with another the old machine was purchased 3years ago for an installed cost of 10000 USD The firm is depreciating the machine under MACRS using a 5 year recovery period ((Depreciation precentages are year 1 =20% year 2 =32% year 3 = 19%) the new machine costs 24000 USD and requires 2000 USD in installation costs the firm is subject to 40% tax rate (a) calculate the initial investement for the replacement if the firm is able to sell the old machine for 7000 USD ? (b) New machine will operate 6 years it will generate after tax incremental cash flow of 4000 USD per year at the end of the sixth year book value and market value of the machine are estimated to be 0. edwards manufacturing cost of capitalis 12% should the replacement be made ?

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Answer #1

a. Initial Investment after Replacement

Book Value of Old Machine at the end of Year 3 = Cost * (1 - 0.20 - 0.32 - 0.19)

Book Value of Old Machine at the end of Year 3 = 10000 * (1 - 0.20 - 0.32 - 0.19)

Book Value of Old Machine at the end of Year 3 = $2900

After Tax Value of Old Machine = Sale Value - (Sale Value - Book Value) * Tax Rate

After Tax Value of Old Machine = 7000 - (7000 - 2900) * 0.40

After Tax Value of Old Machine = 7000 - $1640

After Tax Value of Old Machine = $5360

Initial Investment after Replacement = Cost of New Machine + Installation cost - After Tax Value of Old Machine

Initial Investment after Replacement = 24000 + 2000 - 5360

Initial Investment after Replacement = $20640

b. Computation of NPV

As the NPV is negative, Replacement is not recommended.

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