Blackstone Inc. manufactures western boots and saddles. The company is considering replacing an outmoded leather processing machine with a new, more efficient model. The old machine was purchased for $48,000 six years ago and was expected to have an eight-year life. It has been depreciated on a straightline basis (ignore partial-year conventions). The used machine has an estimated market value of $15,323. The new machine will cost $60,000 and will be depreciated straight line over five years. All depreciation assumes zero salvage. The new machine is expected to last eight years (its economic life), and then will have to be replaced. Assume it has no actual salvage value at that time.
Assume Blackstone’s marginal tax rate is 35%.
Operating cost savings are summarized as follows.
The shop supervisor feels the new machine will produce a higher quality output and thus affect customer satisfaction and repeat sales. She thinks that benefit should be worth at least $5,000 a year, but doesn’t have a way to document the figure. Losses generate tax credits.
a. Calculate the relatively certain incremental cash flows associated with the new machine over its projected economic life of eight years and the NPV at a cost of capital of 12% based on those cash flows. (Round to whole dollar.)
b. Suppose the foreman’s $5,000 quality improvement estimate were to be included. How big an impact would it have in relation to the other numbers? Comment.