You are thinking of purchasing a new machine (NEW) for your business operations and replacing the existing machine (OLD), which you have used for the past 3 years. The new machine will cost $75,000 and will be useful to your business for 5 years after which it can be sold to fetch a salvage value of $9,000. The new machine will be depreciated straight· line to 0 over 5 years. The old machine was purchased for $70,000 and is also being depreciated straight· line to 0 over 5 years. The old machine can be sold today for $30,000, but if you waited for 5 years it will be worth only $6,500 at that time.
The new machine is expected to significantly boost the efficiency of your business operations. Annual savings in operating costs are expected to be $12,000. Also, your net working capital requirement will decline annually by $4,000. Your business pays tax at the rate of 35% and has a cost of capital rate of 12%. Does it make sense for you to replace the OLD machine with the NEW machine?