In: Accounting
One year ago, your company purchased a machine used in manufacturing for $110,000. You have learned that a new machine is available that offers many advantages and you can purchase it for $155,000 today. It will be depreciated on a straight-line basis over 10 years and has no salvage value. You expect that the new machine will produce a gross margin (revenues minus operating expenses other than depreciation) of $60,000 per year for the next 10 years. The current machine is expected to produce a gross margin of $22,000 per year. The current machine is being depreciated on a straight-line basis over a useful life of 11 years, and has no salvage value, so depreciation expense for the current machine is $10,000 per year. The market value today of the current machine is $45,000. Your company's tax rate is 42 % and the opportunity cost of capital for this type of equipment is 10%.
Should your company replace its year-old machine?
The NPV of replacing the year-old machine is ___?
Solution:
Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 | Year 8 | Year 9 | Year 10 | |
New Machine NPV | |||||||||||
Investment | (155,000) | ||||||||||
Net Sale proceed (sale+ tax saving) | 68100 | ||||||||||
= 45,000 + (100,000 - 45000)*42% | |||||||||||
Net Operating Income | 60,000 | 60,000 | 60,000 | 60,000 | 60,000 | 60,000 | 60,000 | 60,000 | 60,000 | 60,000 | |
Depreciation | 15,500 | 15,500 | 15,500 | 15,500 | 15,500 | 15,500 | 15,500 | 15,500 | 15,500 | 15,500 | |
Income before tax (Operating Income - Dep.) | 44,500 | 44,500 | 44,500 | 44,500 | 44,500 | 44,500 | 44,500 | 44,500 | 44,500 | 44,500 | |
Tax @ 42% on Income | 18,690 | 18,690 | 18,690 | 18,690 | 18,690 | 18,690 | 18,690 | 18,690 | 18,690 | 18,690 | |
Income after tax (Income - Tax) | 25,810 | 25,810 | 25,810 | 25,810 | 25,810 | 25,810 | 25,810 | 25,810 | 25,810 | 25,810 | |
Depreciation | 15,500 | 15,500 | 15,500 | 15,500 | 15,500 | 15,500 | 15,500 | 15,500 | 15,500 | 15,500 | |
Cash Flow (Income after tax+ Dep.) | 41,310 | 41,310 | 41,310 | 41,310 | 41,310 | 41,310 | 41,310 | 41,310 | 41,310 | 41,310 | |
Net Cash Flow (investment + annual cash flow) | (86,900) | 41,310 | 41,310 | 41,310 | 41,310 | 41,310 | 41,310 | 41,310 | 41,310 | 41,310 | 41,310 |
Discounting Factor @ 10% | 1.0000 | 0.9091 | 0.8264 | 0.7513 | 0.6830 | 0.6209 | 0.5645 | 0.5132 | 0.4665 | 0.4241 | 0.3855 |
NPV year wise | (86,900.00) | 37,554.55 | 34,140.50 | 31,036.81 | 28,215.29 | 25,650.26 | 23,318.42 | 21,198.56 | 19,271.42 | 17,519.47 | 15,926.79 |
Gross NPV | 166,932.07 | ||||||||||
Old Machine NPV | |||||||||||
Investment | - | ||||||||||
Net Operating Income | 22,000 | 22,000 | 22,000 | 22,000 | 22,000 | 22,000 | 22,000 | 22,000 | 22,000 | 22,000 | |
Depreciation | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | |
Income before tax (Operating Income - Dep.) | 12,000 | 12,000 | 12,000 | 12,000 | 12,000 | 12,000 | 12,000 | 12,000 |
12,000<
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