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Question 10 Toyota Co

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Question 10
Toyota Co. is considering replacing a machine that checks the safety of gas pedals from outside venders. The old machine was purchased 5 years ago for $20,000 and is being depreciated on a straight-line basis over 10 years to a salvage value of $0. If the old machine is sold today, it will sell for its scrap value of $100 (no one would want to use it for testing).

The new machine would cost $35,000 and an additional $2,000 installation cost would be incurred. The new machine will be depreciated on a straight-line basis over 5 years to a salvage value $5,000. Both the cost of the machine and the installation cost will be capitalized and depreciated. At the end of 5 years, the new machine could be sold for $5,000 (in today's dollars). The new machine is much more efficient, so Toyota will have to increase its inventory of gas pedals by $5,000. If the new machine is purchased, repair and maintenance expenses will be $1,000 per year, compared to $3,000 per year (in today's dollars) for the old machine. The new machine will reduce the cost of testing gas pedals (including the cost of falsely accepting bad pedals) by $0.06 per pedal in today’s dollars. The machine will be used to test 100,000 pedals each year.

Assume that the marginal tax rate faced by Toyota is 35%. What is the NPV of the investment if the opportunity cost of capital is 11% (note that this is a nominal rate) and the annual rate of inflation is 3%?