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- July 29th 2009, 09:39 AM #1

- Joined
- Jan 2009
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- 23

## Keep or buy?

5. Newfound must also look at the possibility of replacing another one of its machines. The current machine also cost $100,000. It was purchased when the company started on the Colliers waterfront in November of 2002. Newfound has a buyer for this machine today at $65,000. If they keep it they’ll have to hold on to it for another five years at which time they’ll get $10,000 from a scrap dealer. The new machine would cost $150,000 and save $50,000 in variable costs, but in five years it will be a worthless piece of junk! What would you do?

(CCA rates, tax rates and required return are given in question 4, if you really need ‘em!).

CCA rate - 20%

Tax Rate- 40%

required return - 10%

Here’s what I’ve done so far...

**Current Machine Cost: $100,000**

**Bought: November 2002**

**Salvage Value Now: $65,000**

**New Machine Cost: $150,000**

**Variable Cost savings: $50,000**

**Salavage Value at the end: 0**

**Tax rate: 40%**

**CCA Rate: 20%**

**Required Return On Investment: 10%**

**We know no matter what we choose, the current machine cost is irrelevant to us in this decision. It is a sunk cost. Because there is no reference to the savings being pre-tax or post-tax, we are going to assume the numbers are pre-tax.**

**So, we should find the present value of our increased operating income (aka variable cost savings), assuming we decide to go with the new machine:**

**After-tax = Savings for one year x (1 – tax rate)**

**= $50,000 X (1 - .40)**

**= $30,000**

**Present-value = After-tax x (1 – 1/(required ROI)time)/required ROI**

**= $30,000 x (1 – 1/(1.105)) / 0.10**

**= $113,723,60**

Ok. Here's my questions:

1) Do we really need the CCA rate, tax rate, and required ROI?

2) I know I have to go after the NPV of the salvage value of the new machine. Can it be a negative number or is it 0?

Thanks,

Ibrox