Morrison Limited has an opportunity to purchase new, more efficient production equipment to replace existing machinery. The new machine will cost $850,000 and has an expected 8 year life and a salvage value of $125,000.
The existing machine can be sold for $255,000. It is estimated that 8 years from now the salvage value of the old equipment will be zero.
Annual cash flows to be generated by the new machine through productivity improvements are estimated at $198,000 per year (before tax).
The equipment is in Class 8 and Morrison's tax rate is 40%. Morrison uses a cost of capital of 15%.
Required:
Using NPV analysis, should the new equipment be purchased? Assume the asset will be disposed of on January 1 of year 9 for tax purposes and there will be assets remaining in the pool.

Question

Quizplus · Accepted Answer

The Answer of Morrison Limited has an opportunity to purchase new, more efficient production equipment to replace existing machinery. The new machine will cost $850,000 and has an expected 8 year life and a salvage value of $125,000.
The existing machine can be sold for $255,000. It is estimated that 8 years from now the salvage value of the old equipment will be zero.
Annual cash flows to be generated by the new machine through productivity improvements are estimated at $198,000 per year (before tax).
The equipment is in Class 8 and Morrison's tax rate is 40%. Morrison uses a cost of capital of 15%.
Required:
Using NPV analysis, should the new equipment be purchased? Assume the asset will be disposed of on January 1 of year 9 for tax purposes and there will be assets remaining in the pool.

Morrison Limited Has an Opportunity to Purchase New, More Efficient