The general manager of Mission Impossible Company has proposed the purchase of one of two large six-colour presses designed for long, high-quality runs. The purchase of a new press would enable the firm to reduce its cost of labour and therefore the price to the clients, putting the firm in a more competitive position. The key financial characteristics of the existing press and the two proposed presses are summarised below.
Old press: Originally purchased three years ago at an installed cost of $400,000, it is being depreciated using a straight-line method over a 10-year effective life. The old press has a remaining economic life of five years. It can be sold today to net $460,000 before taxes. If the old press is retained, it can be sold to net $150,000 before taxes at the end of five years.
Press A: This highly automated press can be purchased for $830,000 plus $40,000 in installation costs. It will be depreciated using the straight-line method over a five-year effective life. At the end of the five years, the machine could be sold to net $400,000 before taxes.
Press B: This press is not as sophisticated as press A. It costs $640,000 plus $20,000 in installation costs. It will be depreciated using the straight-line method over a five-year effective life. At the end of five years, it can be sold to net $330,000 before taxes. The firm estimates that its earnings before depreciation and taxes with the old press and with press A or press B for each of the five years will be as show in the table. Assume the firm is subject to a 30% tax rate on ordinary income and NZ tax rule applies on capital gain (capital gain is not taxed).
The firm’s cost of capital applicable to the proposed replacement is 14%. Profit before depreciation and taxes for Design Impression Company’s presses Year Old press Press A Press B 1 $120,000 $250,000 $210,000 2 120,000 270,000 210,000 3 120,000 300,000 210,000 4 120,000 330,000 210,000 5 120,000 370,000 210,000 Recommend which, if either, of the presses the firm should acquire.
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