BL Company currently sells product A. The company has signed a five-year exclusive contract to sell 1,000,000 units per year of product A at a locked-in sales price of $3.80 per unit. The company manufactures the product with a machine that it purchased 3 years ago at a cost of $700,000 and has a book value of $450,000. The machine is expected to last another 5 years, after which it will have no salvage value. Last year, the production variable costs per unit were as follows: Direct materials $1.20, Direct labor $0.70, Variable overhead $0.50, Total variable cost per unit $2.40. The company president is considering replacing the old machine with a new one that would cost $800,000 and will take the old machine as a trade-in for $230,000. The new machine is expected to last 5 years. At the end of that period, the salvage value will be $350,000. The president expects to save 5% of the company's total variable costs with the new machine. Assume that the company's cost of capital is 12%, income tax rate is 40%, and depreciation is calculating on a straight-line rate for both accounting and tax purposes, determine if the company should replace the old machine with the new one? Calculate the Net Present Value of the decision.
