The Dauten Toy Corporation currently uses an injection molding machine that was purchased 2 years ago. This machine is being depreciated on a straight-line basis, and it has 6 years of remaining life. Its current book value is $2,100, and it can be sold for $2,500 at this time. Thus, the annual depreciation expense is $2,100/6 at $350 per year. If the old machine is not replaced, it can be sold for $500 at the end of its useful life.
Dauten is offered a replacement machine which has a cost of $8,000, an estimated useful life of 6 years, and an estimated salvage value of $800. This machine falls into the MACRS 5-year class so the applicable depreciation rates are 20, 32, 19, 12, 11, and 6 percent. The replacement machine would permit an output expansion, so sales would rise by $1,000 per year; even so, the new machine’s much greater efficiency would still cause operating expenses to decline by $1,500 per year. The new machine would require that inventories be increased by $2,000, but accounts payable would simultaneously increase by $500. Dauten’s marginal federal-plus-state tax rate is 40 percent, and its WACC is 15 percent. Should it replace the old machine?
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