Question

As a result of improvements in product engineering, United Automation is able to sell one of its two milling machines. Both machines perform the same function but differ in age. The newer machine could be sold today for $53,000. Its operating costs are $20,400 a year, but at the end of five years, the machine will require a $19,800 overhaul (which is tax deductible). Thereafter, operating costs will be $30,200 until the machine is finally sold in year 10 for $5,300. The older machine could be sold today for $25,200. If it is kept, it will need an immediate $21,000 (tax-deductible) overhaul. Thereafter, operating costs will be $29,800 a year until the machine is finally sold in year 5 for $5,300. Both machines are fully depreciated for tax purposes. The company pays tax at 21%. Cash flows have been forecasted in real terms. The real cost of capital is 10%.

Calculate the equivalent annual costs for selling the new machine and for selling the old machine. (Do not round intermediate calculations. Enter your answers as a positive value rounded to 2 decimal places.)

a)Sell New Machine, Equivalent Annual Cost:?

b)Sell Old Machine, Equivalent Annual Cost:?

Answer 1

(a) Net cash inflow in year 0

Proceeds from sale of old machine	53,000
Overhaul expense	(21,000)
Tax paid on Gain [53,000 - 21,000] x 21%	(6,720)
Net cash flows for year 0	25,280

Particulars	Year	Amount	PV@10%	Discounted value
Cash flow at year 0	0	25,280	1	25,280
operating costs	1-5	(29,800)	3.7908	(112,966)
Salvage value [5,300 - (5,300 x 21%)]	5	4,187	0.6209	2,600
			NPV	(85,086)

EAC for 5 years = 85,086/ 3.7908 = $22,445.39

(b)

Particulars	Year	Amount	PV@10%	Discounted value
Cash flow at year 0 [25,200 - (25,200 x 21%)]	0	19,908	1	19,908
Operating costs	1-5	(20,400)	3.7908	(77,332)
Overhaul expense [19,800 - (19,800 x 21%)]	5	(15,642)	0.6209	(9,712)
Operating costs	6-10	(30,200)	2.3538	(71,085)
Salvage value [5,300 - (5,300 x 21%)]	10	4,187	0.3855	1,614
			NPV	(136,607)

EAC for 10 years = 136,607/ 6.1446 = $22,232.04