Making Capital Investment Decisions

Isaac, Inc. is thinking about purchasing a new machine to replace an old one. The new
machine would cost $300,000. The machine will have a life of 6 years and will be
depreciated using the 5-Year MACRS table (page 275 in book). The machine has a
salvage value $35,000 at the end of its life and will be sold then. This machine is
expected to produce cost savings of $20,000 per year over the old machine. The old
machine had a twelve year life and was purchased for $500,000 6 years ago with a
salvage value of $8,000. It is depreciated using the straight-line method. The machine
can be sold right now for $260,000 and can be sold for $8,000 in 6 years. It will take
$5,000 in net working capital to maintain the new machine. The company has a required
return of 10% and is in the 40% tax bracket. Calculate the NPV of the project and
determine if the company should replace the old machine with the new one.
Year
Cost Savings
New Deprec.
Old Deprec.
Incremental
EBIT
Taxes
Net Income

OCF
Year
OCF
Change in
NWC
Capital
Investment
Net CF