Question

ABC Co is considering replacing an old power generator with a new one. the old one was purchased 5 years ago for $100,000. It is depreciated straightline to zero over its 10 year life. it is expected to be worthless at the end of its 10 year life. if ABC sells it today, ABC should receive $65,000 for the generator. the new generator costs $150,000. it has a life of 5 years and will be depreciated straightline to zero over its 5 year life. it is expected to be worthless at the end of its 5 year life. the new generator is expected to reduce the operating costs by $50,000 per year. there is no change in net working capital. the discount rate of this replacement is 15% and the tax rate is 40%.

Answer 1

For old machine, Depreciation expense is 100000/10 or $10000 per year cost the tax savings is $10000*40% or $4000 per year

The present value of $4000 savings per year is $13408.62. Calculation is given below:

For new machine depreciation expense is 150000/5 or $30000 per year

New Genrator
Year	Cash Flow/Cost Savings	Depreciation expense	Tax ((B+C)*Tax rate	Net Savings ( Cash flow -tax)	Present Value of Net Savings (Net Savings/1.15^year)
0	(150,000.00)	0	0	(150,000.00)	(150,000.00)
1	50000	-30000	8000	42000	36,521.74
2	50000	-30000	8000	42000	31,758.03
3	50000	-30000	8000	42000	27,615.68
4	50000	-30000	8000	42000	24,013.64
5	50000	-30000	8000	42000	20,881.42
				NPV	(9,209.49)

As The present Value of Cost Savings is more old machine and also if the company sells out old machine it will give a positive cash flow of $65000, the old machine should be used instead of new machine.