Question

Taylor Toy Corp. is considering the replacement of it injection molding machine. It is 2 years old but new

technology has it considering the newest model.

• The old (current) machine was acquired 2 years ago and is being depreciated on a straight line basis over 8 years (6 years remaining).The annual depreciation expense is $350 per year, and its current book value is $2,100. It can be sold for $2,500 today. If the machine is not replaced, it is expected to be sold for $500 at the end of its remaining life (6 yrs).

• The new, replacement machine will cost $8,000. It is expected to be used for 6 years, and is expected to be sold for $800 then. It will be depreciated using MACRS (5-year class with 1⁄2 year convention).

• The new machine is expected to support an increase in sales by $1,000 per year, and with its improved electrical efficiency, it should reduce operating expenses by $1,500 per year.

• Inventories will need to increase by $2,000 and Account payable will increase by $500.

• The company’s tax rate is 40%.

• Taylor Toy’s Cost of Capital is 15%, which is the appropriate Hurdle Rate for this project.

  Using a blank workbook (not a template ...), evaluate this project:

  1. Present the cash flows

  2. Calculate the evaluation measures.

  3. Should Cookeville Technical Productions replace the machine?

Answer 1

Post tax salvage value of old machine today = Sale price - tax = Sale price - (Sale price - book value) x Tax rate = 2,500 - (2,500 - 2,100) x 40% = $  2,340.00

Post tax salvage value of old machine opportunity lost at the end of year 6 from now = Sale price - tax = Sale price - (Sale price - book value) x Tax rate = 500 - (500 - 0) x 40% = $ 300

Please see the table below. Please be guided by the second column titled “Linkage” to understand the mathematics. The last row highlighted in yellow is your answer. Figures in parenthesis, if any, mean negative values. All financials are in $. Adjacent cells in blue contain the formula in excel I have used to get the final output.

Present the cash flows: they are there in the table above

Calculate the evaluation measures: The evaluation measure will be NPV and it turns outs to be $ 921.73

Should Cookeville Technical Productions replace the machine? Yes, since NPV turns out to be positive, this replacement should be done.