In: Finance
One year ago, your company purchased a machine used in manufacturing for $ 120,000. You have learned that a new machine is available that offers many advantages; you can purchase it for $ 140,000 today. It will be depreciated on a straight-line basis over ten years, after which it has no salvage value. You expect that the new machine will contribute EBITDA (earnings before interest, taxes, depreciation, and amortization) of $ 55,000 per year for the next ten years. The current machine is expected to produce EBITDA of $ 23,000 per year. The current machine is being depreciated on a straight-line basis over a useful life of 11 years, after which it will have no salvage value, so depreciation expense for the current machine is $ 10,909 per year. All other expenses of the two machines are identical. The market value today of the current machine is $ 50,000. Your company's tax rate is 40 %, and the opportunity cost of capital for this type of equipment is 12 %. Is it profitable to replace the year-old machine?
Book value old machine = (purchase price)*remaining life/total life | |
= (120000)*10/11 | |
= 109090.91 |
Time line | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | |||
Proceeds from sale of existing asset | =selling price* ( 1 -tax rate) | 30000 | ||||||||||||
Tax shield on existing asset book value | =Book value * tax rate | 43636.364 | ||||||||||||
Cost of new machine | -140000 | |||||||||||||
=Initial Investment outlay | -66363.636 | |||||||||||||
100.00% | ||||||||||||||
EBIDTA2-EBITA1= | 55000-23000= | 22000 | 22000 | 22000 | 22000 | 22000 | 22000 | 22000 | 22000 | 22000 | 22000 | |||
-Depreciation | Cost of equipment/no. of years | -14000 | -14000 | -14000 | -14000 | -14000 | -14000 | -14000 | -14000 | -14000 | -14000 | 0 | =Salvage Value | |
=Pretax cash flows | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | 8000 | ||||
-taxes | =(Pretax cash flows)*(1-tax) | 4800 | 4800 | 4800 | 4800 | 4800 | 4800 | 4800 | 4800 | 4800 | 4800 | |||
+Depreciation | 14000 | 14000 | 14000 | 14000 | 14000 | 14000 | 14000 | 14000 | 14000 | 14000 | ||||
=after tax operating cash flow | 18800.00 | 18800.00 | 18800 | 18800 | 18800 | 18800 | 18800 | 18800 | 18800 | 18800 | ||||
+Tax shield on salvage book value | =Salvage value * tax rate | 0 | ||||||||||||
=Terminal year after tax cash flows | 0 | |||||||||||||
Total Cash flow for the period | -66363.636 | 18800 | 18800 | 18800 | 18800 | 18800 | 18800 | 18800 | 18800 | 18800 | 18800 | |||
Discount factor= | (1+discount rate)^corresponding period | 1 | 1.12 | 1.2544 | 1.404928 | 1.5735194 | 1.7623417 | 1.9738227 | 2.210681407 | 2.4759632 | 2.773079 | 3.105848 | ||
Discounted CF= | Cashflow/discount factor | -66363.636 | 16785.714 | 14987.245 | 13381.469 | 11947.74 | 10667.625 | 9524.6651 | 8504.165248 | 7593.0047 | 6779.468 | 6053.097 | ||
NPV= | Sum of discounted CF= | 39860.56 |
Replace machine as NPV is positive