Question

In: Finance

One year​ ago, your company purchased a machine used in manufacturing for $ 120,000. You have...

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?

Solutions

Expert Solution

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


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