Drexler Company is contemplating the replacement of one of its machines with a newer and more efficient one. The old machine has a book value of $500,000 and a remaining useful life of 5 years. The firm can sell it now to another firm in the industry for $300,000. The old machine is being depreciated toward a $100,000 salvage value, or by $80,000 per year, using the straight line method. The new machine has a purchase price of $1.1 million, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $180,000. It is expected to economize on electric power usage, labor, and repair costs. In total, an annual saving of $280,000 will be realized if it is installed. But if the new machine is purchased, the net working capital should increase by $40,000 (at t=0). The company is in the 34 percent tax bracket, and it has a 10 percent cost of capital. Should the firm accept the replacement project? Show your work comparing the two alternatives, replace and non-replacement.
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