Question

One year​ ago, your company purchased a machine used in manufacturing for $95,000.You have learned that a new machine is available that offers many advantages and that you can purchase it for$160,000 today. The CCA rate applicable to both machines is 20%​; neither machine will have any​ long-term salvage value. You expect that the new machine will produce earnings before​ interest, taxes,​ depreciation, and amortization (EBITDA​) of $55,000 per year for the next ten years. The current machine is expected to produce EBITDA of $25,000 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 38%​, and the opportunity cost of capital for this type of equipment is 11%.

Should your company replace its​ year-old machine?

Answer 1

	New machine	Old machine	Increment
Cost	160,000.00	50,000.00	110,000.00
EBITDA	55,000.00	25,000.00	30,000.00

	Incremental Depreciation	0.2		0.2
Year	written down new machine	Depreciation 20%	written down old machine(1year old)	Depreciation 20%	Increment in depreciation
1	160,000.00	32,000.00	76,000.00	15,200.00	16,800.00
2	128,000.00	25,600.00	60,800.00	12,160.00	13,440.00
3	102,400.00	20,480.00	48,640.00	9,728.00	10,752.00
4	81,920.00	16,384.00	38,912.00	7,782.40	8,601.60
5	65,536.00	13,107.20	31,129.60	6,225.92	6,881.28
6	52,428.80	10,485.76	24,903.68	4,980.74	5,505.02
7	41,943.04	8,388.61	19,922.94	3,984.59	4,404.02
8	33,554.43	6,710.89	15,938.36	3,187.67	3,523.22
9	26,843.55	5,368.71	12,750.68	2,550.14	2,818.57
10	21,474.84	4,294.97	10,200.55	2,040.11	2,254.86

Year	PV factor 11% [1/(1+r)^n]
1	0.901
2	0.812
3	0.731
4	0.659
5	0.593
6	0.535
7	0.482
8	0.434
9	0.391
10	0.352

Incremental cashflow method
Year	1	2	3	4	5	6	7	8	9	10
EBITDA	30,000.00	30,000.00	30,000.00	30,000.00	30,000.00	30,000.00	30,000.00	30,000.00	30,000.00	30,000.00
Less Depreciation	16,800.00	13,440.00	10,752.00	8,601.60	6,881.28	5,505.02	4,404.02	3,523.22	2,818.57	2,254.86
EBIT	13,200.00	16,560.00	19,248.00	21,398.40	23,118.72	24,494.98	25,595.98	26,476.78	27,181.43	27,745.14
Tax 38%	5,016.00	6,292.80	7,314.24	8,131.39	8,785.11	9,308.09	9,726.47	10,061.18	10,328.94	10,543.15
EAT	8,184.00	10,267.20	11,933.76	13,267.01	14,333.61	15,186.89	15,869.51	16,415.61	16,852.49	17,201.99
Add Depreciation	16,800.00	13,440.00	10,752.00	8,601.60	6,881.28	5,505.02	4,404.02	3,523.22	2,818.57	2,254.86
Incremental Cashflow (a)	24,984.00	23,707.20	22,685.76	21,868.61	21,214.89	20,691.91	20,273.53	19,938.82	19,671.06	19,456.85
Discount factor (b)	0.901	0.812	0.731	0.659	0.593	0.535	0.482	0.434	0.391	0.352
Discounted inflow(a*b)	22,508.11	19,241.30	16,587.63	14,405.53	12,590.00	11,062.74	9,764.91	8,651.98	7,689.90	6,852.40
Total Discounted inflow	129,354.51
Less: Incremental Initial outflow	110,000.00
NPV of the replacement	19,354.51
Since NPV is positive , it is advisable to purchase the new machine