Benson Enterprises is deciding when to replace its old machine. The machine’s current salvage value is $1.2 million. Its current book value is $1 million. If not sold, the old machine will require maintenance costs of $420,000 at the end of the year for the next five years. Depreciation on the old machine is $200,000 per year. At the end of five years, it will have a salvage value of $220,000. A replacement machine costs $3.5 million now and requires maintenance costs of $160,000 at the end of each year during its economic life of five years. At the end of five years, the new machine will have a salvage value of $540,000. It will be fully depreciated using the three-year MACRS schedule. In five years a replacement machine will cost $4,000,000. Pilot will need to purchase this machine regardless of what choice it makes today. The corporate tax is 35 percent and the appropriate discount rate is 10 percent. The company is assumed to earn sufficient revenues to generate tax shields from depreciation. Should Benson Enterprises replace the old machine now or at the end of five years?
Benson Enterprises is deciding when to replace its old machine. The machine’s current salvage
value is $1.2 million. Its current book value is $1 million. If not sold, the old machine will require
maintenance costs of $420,000 at the end of the year for the next five years. Depreciation on the
old machine is $200,000 per year. At the end of five years, it will have a salvage value of $220,000.
A replacement machine costs $3.5 million now and requires maintenance costs of $160,000 at the
end of each year during its economic life of five years. At the end of five years, the new machine
will have a salvage value of $540,000. It will be fully
schedule. In five years a replacement machine will cost $4,000,000. Pilot will need to purchase
this machine regardless of what choice it makes today. The corporate tax is 35 percent and the
appropriate discount rate is 10 percent. The company is assumed to earn sufficient revenues to
generate tax shields from depreciation. Should Benson Enterprises replace the old machine now
or at the end of five years?
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