Replacement decision analyzed by using a total analysis of both the old and new machines or by using an incremental analysis that emphasizes the changes in cash flows between the old and the new machines.
The Lancaster Corporation purchased a piece of equipment three years ago for $250,000. It has an asset depreciation range (ADR) midpoint of eight years. The old equipment can be sold for $97,920.
A new piece of equipment can be purchased for $360,000. It also has an ADR of eight years.
Assume the old and new equipment would provide the following operating gains (or losses) over the next six years.
Year New Equipment Old Equipment
1 $100,000 $36,000
2 86,000 26,000
3 80,000 19,000
4 72,000 18,000
5 62,000 16,000
6 43,000 (9,000)
The firm has a 36 percent tax rate and a 9 percent cost of capital. Should the new equipment be purchased to replace the old equipment?