Vandelay Industries is considering replacing its existing latex machine. The machine was purchased four years ago for $60,000, and is being depreciated on a straight-line basis to zero over ten years (i.e., there are six years of depreciation remaining). The new machine costs $75,000, and will be depreciated on a straight-line basis to a zero salvage value over six years. The new machine will produce the same amount of latex as the old machine, but will operate more efficiently and save $8,000 per year in operating costs. The old machine could be sold today for $30,000. The tax rate is 40%.
(a) Construct a table of the relevant cash flows, and compute the NPV of the replacement decision at a discount rate of 10%.
(b) Now assume that the new machine will be sold for its salvage value at the end of Year 6. Also assume that the salvage value will not change the annual depreciation expense on the new machine - in other words, it will still be depreciated to zero over six years. What is the minimum salvage value that would justify replacing the existing machine? You can solve for this in Excel if you wish, but you must also explain in words or with a mathematical formula how you arrived at the result.