Question: CAPITAL BUDGETING
A Company is using a machine the original cost of which was $370,000. The machine is two years old and has a remaining useful life of 10 years. It is expected that scrapping the old machine in 10 years from now will fetch $10000 but if it is sold now to another firm in the industry it would receive $100,000. The straight line method of depriciation is in effect.
The management is contemplating replacing it with a newer and more efficient machine which costs $420,000 and has an estimated salvage value of $20000 after its useful life of 10 years. The new machine will have a greater capacity and annual returns are expected to go up by $40000 per year. The operating efficiency of the new machine will also produce an expected savings of $50000 a year. The company's tax rate is 55%.A 25% investment allowance will apply if the new machine is purchased,inventories will increase by $50000,receivables by $25000 and payables by $20000 during the life of the project. Determine the economic desirability of the purchase of the machine ,assuming the cost of capital to be 12%.