REPLACEMENT ANALYSIS The Dauten Toy Corporation 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 = $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 that 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%. The replacement machine would permit an output expansion, so sales would rise by $1,000 per year. Even so, the new machine’s greater efficiency would 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%, and its WACC is 15%. Should the company replace the old machine?