Overton Clothes Inc. is considering the replacement of its old, fullydepreciated knitting machine. Two new models are available: (a) Machine 171-3, whichhas a cost of $171,000, a 3-year expected life, and after-tax cash flows (labor savings anddepreciation) of $85,000 per year, and (b) Machine 356-6, which has a cost of $356,000, a6-year life, and after-tax cash flows of $102,400 per year. Assume that both projects can berepeated. Knitting machine prices are not expected to rise because inflation will be offsetby cheaper components (microprocessors) used in the machines. Assume that Overton’sWACC is 13%. Using the replacement chain and EAA approaches, which model should beselected? Why?
Overton Clothes Inc. is considering the replacement of its old, fully
depreciated knitting machine. Two new models are available: (a) Machine 171-3, which
has a cost of $171,000, a 3-year expected life, and after-tax cash flows (labor savings and
depreciation) of $85,000 per year, and (b) Machine 356-6, which has a cost of $356,000, a
6-year life, and after-tax cash flows of $102,400 per year. Assume that both projects can be
repeated. Knitting machine prices are not expected to rise because inflation will be offset
by cheaper components (microprocessors) used in the machines. Assume that Overton’s
WACC is 13%. Using the replacement chain and EAA approaches, which model should be
selected? Why?
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