Duluth Medico purchased a digital imageprocessing machine three years ago at a cost of$50,000. The machine had an expected life of eightyears at the time of purchase and an expected salvagevalue of $5,000 at the end of the eight years. Theold machine has been slow at handling the increasedbusiness volume, so management is consideringreplacing the machine. A new machine can be purchased for $75,000, including installation costs.Over its five-year life, the machine will reduce cashoperating expenses by $30,000 per year. Sales arenot expected to change. At the end of its useful life,the machine is estimated to be worthless. The oldmachine can be sold today for $10,000. The firm’sinterest rate for project justification is known to be15%. The firm does not expect a better machine(other than the current challenger) to be available forthe next five years. Assuming that the economic service life of the new machine, as well as the remaininguseful life of the old machine, is five years,(a) Determine the cash flows associated with eachoption (keeping the defender versus purchasingthe challenger).(b) Should the company replace the defender now?
Duluth Medico purchased a digital imageprocessing machine three years ago at a cost of
$50,000. The machine had an expected life of eight
years at the time of purchase and an expected salvage
value of $5,000 at the end of the eight years. The
old machine has been slow at handling the increased
business volume, so management is considering
replacing the machine. A new machine can be purchased for $75,000, including installation costs.
Over its five-year life, the machine will reduce cash
operating expenses by $30,000 per year. Sales are
not expected to change. At the end of its useful life,the machine is estimated to be worthless. The old
machine can be sold today for $10,000. The firm’s
interest rate for project justification is known to be
15%. The firm does not expect a better machine
(other than the current challenger) to be available for
the next five years. Assuming that the economic service life of the new machine, as well as the remaining
useful life of the old machine, is five years,
(a) Determine the cash flows associated with each
option (keeping the defender versus purchasing
the challenger).
(b) Should the company replace the defender now?
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