Should new equipment be purchased to replace old equipment


Problem:

The Woodruff Corporation purchased a piece of equipment three years ago for $230,000.It has an asset depreciation range(ADR) midpoint of eight years.The old equipment can be sold for $90,000.

A new piece of equipment can be purchased for $320,000.It also has an ADR of 8 years.

Assume the old and new equipment would provide the following operating gains(or losses) over the next 6 years.
____________________________________________
year new equipment old equipment
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1 $80,000 $25,000
2 $76,000 $16,000
3 $70,000 $9,000
4 $60,000 $8,000
5 $50,000 $6,000
6 $45,000 ($7000)

The firm has a 36% tax rate and a 9% cost of capital. Should the new equipment be purchased to replace th old equipment?

Explain why, showing each step.

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Finance Basics: Should new equipment be purchased to replace old equipment
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