Strong Tool Company has been considering purchasing a new lathe as a replacement for a fully depreciated lathe that can last 5 more years. The new lathe is expected to have a 5-year life and depreciation charges of $2,000 in year 1; $3,200 in year 2; $1,900 in year 3; $1,200 in both year 4 and year 5; and $500 in year 6.
The firm estimates the revenues and expenses (excluding depreciation and interest) for the new and the old lathes to be as shown in the following table.
The firm is subject to a 40% tax rate. Should the new lathe be purchased? The price of the new lathe is $ 10,000 and the cost of capital is 10%, annually.
Year New lathe Old lathe
Revenue Expenses (excl. depr. and int.) Revenue Expenses (excl. depr. and int.)
1 $40,000 $30,000 $35,000 $25,000
2 $41,000 $30,000 $35,000 $25,000
3 $42,000 $30,000 $35,000 $25,000
4 $43,000 $30,000 $35,000 $25,000
5 $44,000 $30,000 $35,000 $25,000