Question

This question is similar to question 2 but annual revenue is given and sale value is unknown:
Suppose you have to decide whether sell an old machine or keep it with a major overhaul. You can:

A) Sell the machine at time zero for X dollars with zero book value and paying the tax of 40%.

B) Keep the machine, which requires a major overhaul cost of $1,000,000 at time zero. The overhaul cost is depreciable from time 0 to year 5 (over six years) based on MACRS 5-year life depreciation with the half year convention (table A-1 at IRS (Links to an external site.)Links to an external site.). In this case machine can produce and generate equal annual revenue of 900,000 dollars for five years (year 1 to 5) and salvage value of the machine will be $250,000 with zero book value at the end of year 5. The operating cost of the machine will be $400,000 per year from year 1 to year 5.

Calculate the sale value, X, that can break-even the NPV of keeping the machine. Consider 40% income tax rate and after-tax minimum ROR of 16%.

Answer 1

Particulars	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Annual Revenue		$900000	$900000	$900000	$900000	$900000
Operating cost		$400000	$400000	$400000	$400000	$400000
Less: Macrs Depreciation	20% of 1000000= 2000000	32% of 1000000= 320000	19.2% of 1000000= 192000	11.52% of 1000000= 115200	11.52% of 1000000= 115200	$57600
Salvage value						$250000
Profits before tax	($200000)	$180000	$308000	$384800	$384800	$692400
Less: Tax 40%	$0	$72000	$123200	$153920	$153920	$276960
Incremental earning	($200000)	$108000	$184800	$230880	$230880	$415440
Add: Depreciation	$200000	$320000	$192000	$115200	$115200	$57600
Less: Initial Investment	$1000000
Incremental free cashflow	($1000000)	$428000	$376800	$346080	$346080	$473040
ROR	16%
PV	-1000000	$428000/1.16= $368965.52	$376800/(1.16)^2= $280023.78	$346080/(1.16)^3= $221718.81	$346080/(1.16)^4= $191136.90	$473040/(1.16)^5= $225220.50
NPV(Total of PV)	$287065.51
Sales price of machine X= $287065.51/(1-40%)= $478442.52