In: Finance
One year ago your company purchased a machine for $110,000. You have learned that the new, much better machine is available for $150,000. In will be depreciated on a straight line basis and has no salvage value. You expect the machine to produce $60,000 per year in revenue and cost $20,000 per year to operate for the next ten years. The current machine is expected to produce $40,000 per year in revenue and also costs $20,000 per year to operate. The current machine’s depreciation expense is $10,000 per for the next 10 years, after which it will be discarded. It will have no salvage value. The market value of the current machine today is $50,000. Your company’s tax rate is 45% and the opportunity cost of capital is 10%. Should your company replace its year-old machine
Time line | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | |
Proceeds from sale of existing asset | =selling price* ( 1 -tax rate) | 27500 | ||||||||||
Tax shield on existing asset book value | =Book value * tax rate | 45000 | ||||||||||
Cost of new machine | -150000 | |||||||||||
=Initial Investment outlay | -77500 | |||||||||||
Incremental Profits | 20000 | 20000 | 20000 | 20000 | 20000 | 20000 | 20000 | 20000 | 20000 | 20000 | ||
-Depreciation | Cost of equipment/no. of years | -15000 | -15000 | -15000 | -15000 | -15000 | -15000 | -15000 | -15000 | -15000 | -15000 | |
=Pretax cash flows | 5000 | 5000 | 5000 | 5000 | 5000 | 5000 | 5000 | 5000 | 5000 | 5000 | ||
-taxes | =(Pretax cash flows)*(1-tax) | 2750 | 2750 | 2750 | 2750 | 2750 | 2750 | 2750 | 2750 | 2750 | 2750 | |
+Depreciation | 15000 | 15000 | 15000 | 15000 | 15000 | 15000 | 15000 | 15000 | 15000 | 15000 | ||
=after tax operating cash flow | 17750 | 17750 | 17750 | 17750 | 17750 | 17750 | 17750 | 17750 | 17750 | 17750 | ||
+Tax shield on salvage book value | =Salvage value * tax rate | 0 | ||||||||||
=Terminal year after tax cash flows | 0 | |||||||||||
Total Cash flow for the period | -77500 | 17750 | 17750 | 17750 | 17750 | 17750 | 17750 | 17750 | 17750 | 17750 | 17750 | |
Discount factor= | (1+discount rate)^corresponding period | 1 | 1.1 | 1.21 | 1.331 | 1.4641 | 1.61051 | 1.771561 | 1.9487171 | 2.1435888 | 2.357948 | 2.593742 |
Discounted CF= | Cashflow/discount factor | -77500 | 16136.36364 | 14669.421 | 13335.838 | 12123.489 | 11021.353 | 10019.412 | 9108.556599 | 8280.506 | 7527.733 | 6843.393 |
NPV= | Sum of discounted CF= | 31566.06613 |
Buy new machine as incremental NPV is positive