Problem:
The Moon Company is contemplating the purchase of a new machine to replace an old machine. The following data are available concerning this investment possibility:
New machine:
Purchase price now $50,000
Annual cash operating costs $20,000
Useful life 7 years
Salvage value at the end of seven years $ 3,000
Old machine:
Original purchase price three years ago $40,000
Book value now $20,000
Annual cash operating costs $30,000
Salvage value at the end of seven years $ 2,000
Overhaul needed four years from now $ 7,000
Salvage value of the machine now $20,000
The machine is in the MACRS 5-year property class and would be depreciated using the MACRS tables. The old machine is also in the 5-year property class and is being depreciated by the optional straight-line method. However, this old machine could last seven more years if overhauled in four years. The company requires a 12% after-tax return on all equipment purchases, and the tax rate is 30%. The following questions are based on the total-cost approach to the net present value method:
From the point of view of keeping the old machine, the present value of the overhaul needed at the end of Year 4 is closest to:
A) $(4,900). C) $(7,000).
B) $(5,675). D) $(3,116).