Blue Sky Ltd. is considering the replacement of one of its older machines that is still capable of doing the job but is considerably inefficient. A new machine costing $150,000 will reduce annual operating costs from $50,000 per year to $20,000 per year. The new machine will last 10 years and will be amortized for tax purposes at 30 percent. The older machine has a book value of $46,500. The older machine could be sold for $27,500 today. In 10 years the older machine could be scrapped for $8,000, whereas the new machine would still be worth $32,000. Also, the older machine requires a spare parts inventory (not eligible for tax-related amortization) of $5,000 that is not required by the newer machine. Blue Sky’s tax rate is 28 percent, and its cost of capital is 15 percent. Would you advise Blue Sky to replace the older machine?Assume the PV of the tax benefits is $39,000.
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Blue Sky Ltd. is considering the replacement of one of its older machines that is still capable of doing the job but is considerably inefficient. A new machine costing $150,000 will reduce annual operating costs from $50,000 per year to $20,000 per year. The new machine will last 10 years and will be amortized for tax purposes at 30 percent. The older machine has a book value of $46,500. The older machine could be sold for $27,500 today. In 10 years the older machine could be scrapped for $8,000, whereas the new machine would still be worth $32,000.
Also, the older machine requires a spare parts inventory (not eligible for tax-related amortization) of $5,000 that is not required by the newer machine. Blue Sky’s tax rate is 28 percent, and its cost of capital is 15 percent. Would you advise Blue Sky to replace the older machine?Assume the PV of the tax benefits is $39,000.
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