The Woodruff Corporation purchased a piece of equipment three years ago for $230,000. It has an asset depreciation range (ADR) midpoint of eight years. The old equipment can be sold for $90,000.
A new piece of equipment can be purchased for $320,000. 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:
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Ye New Equipment Old Equipment Year
1 $80,000 $25,000 1
2 76,000 16,000 2
3 70,000 9,000 3
4 60,000 8,000 4
5 50,000 6,000 5
6 45,000 (7,000) 6
Question: The firm has a 25 percent tax rate and a 9 percent cost of capital. Should the new equipment be purchased to replace the old equipment? Explain your answer.