REPLACEMENT ANALYSIS

12-4 REPLACEMENT ANALYSIS

The Oviedo Company is considering the purchase of a newmachine to replace an obsolete one. The machine being used for the operation has a bookvalue and a market value of zero. However, the machine is in good working order and willlast at least another 10 years. The proposed replacement machine will perform the opera-tion so much more efficiently that Oviedo’s engineers estimate that it will produce after-taxcash flows (labor savings and depreciation) of $8,000 per year. The new machine will cost $45,000 delivered and installed, and its economic life is estimated to be 10 years. It has zerosalvage value.

The firm’s WACC is 10%, and its marginal tax rate is 35%. Should Oviedobuy the new machine?

Solution: