Question
In: Finance
One year ago, your company purchased a machine used in manufacturing for $ 105000. You have...
One year ago, your company purchased a machine used in manufacturing for $ 105000. You have learned that a new machine is available that offers many advantages; you can purchase it for $ 160000 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 $ 40000 per year for the next ten years. The current machine is expected to produce EBITDA of $ 21000 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 $ 9545 per year. All other expenses of the two machines are identical. The market value today of the current machine is $ 50000. Your company's tax rate is 42 %, and the opportunity cost of capital for this type of equipment is 10 %. Is it profitable to replace the year-old machine?
Solutions
Expert Solution
The replacement decision can be done by use of comparative analysis of present value for both the machine.
| Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | 11 |
| Old Machine | ||||||||||||
| Cost | -105000 | |||||||||||
| Current value | 50000 | |||||||||||
| Loss on sell of machine | -45454.5 | (105000-9545.45)-50000 | ||||||||||
| EBITDA | 21000 | 21000 | 21000 | 21000 | 21000 | 21000 | 21000 | 21000 | 21000 | 21000 | 21000 | |
| Depreciation | -9545.45 | -9545.45 | -9545.45 | -9545.45 | -9545.45 | -9545.45 | -9545.45 | -9545.45 | -9545.45 | -9545.45 | -9545.45 | |
| EBIT | 11454.55 | 11454.55 | 11454.55 | 11454.55 | 11454.55 | 11454.55 | 11454.55 | 11454.55 | 11454.55 | 11454.55 | 11454.55 | |
| Tax | -4810.91 | -4810.91 | -4810.91 | -4810.91 | -4810.91 | -4810.91 | -4810.91 | -4810.91 | -4810.91 | -4810.91 | -4810.91 | |
| Net profit | 6643.636 | 6643.636 | 6643.636 | 6643.636 | 6643.636 | 6643.636 | 6643.636 | 6643.636 | 6643.636 | 6643.636 | 6643.636 | |
| Free cash flow | 16189.09 | 16189.09 | 16189.09 | 16189.09 | 16189.09 | 16189.09 | 16189.09 | 16189.09 | 16189.09 | 16189.09 | 16189.09 | |
| PV (Cash flow @10%) | 14717.36 | 13379.41 | 12163.1 | 11057.37 | 10052.15 | 9138.32 | 8307.563 | 7552.33 | 6865.755 | 6241.595 | 5674.178 | |
| PV total cash flow | 105149.1 | |||||||||||
| Net Value | PV(cash flow)- Loss of sales of machine | 59694.59 | ||||||||||
| Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | |
| New Machine | -160000 | |||||||||||
| EBITDA | 40000 | 40000 | 40000 | 40000 | 40000 | 40000 | 40000 | 40000 | 40000 | 40000 | ||
| Depreciation | -16000 | -16000 | -16000 | -16000 | -16000 | -16000 | -16000 | -16000 | -16000 | -16000 | ||
| EBIT | 24000 | 24000 | 24000 | 24000 | 24000 | 24000 | 24000 | 24000 | 24000 | 24000 | ||
| Tax | -10080 | -10080 | -10080 | -10080 | -10080 | -10080 | -10080 | -10080 | -10080 | -10080 | ||
| Net profit | 13920 | 13920 | 13920 | 13920 | 13920 | 13920 | 13920 | 13920 | 13920 | 13920 | ||
| Free cash flow | 29920 | 29920 | 29920 | 29920 | 29920 | 29920 | 29920 | 29920 | 29920 | 29920 | ||
| PV (Cash flow @10%) | 27200 | 24727.27 | 22479.34 | 20435.76 | 18577.97 | 16889.06 | 15353.69 | 13957.9 | 12689 | 11535.46 | ||
| PV total cash flow | 183845.4 | |||||||||||
| Net Value | PV(cash flow)- Cost of machine | 23845.45 | ||||||||||
As the net Value of old machine is higher than the New machine,
Decision: machine shouldn't be replaced.
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