Question

In: Accounting

One year​ ago, your company purchased a machine used in manufacturing for $110,000. You have learned...

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 ___?

Solutions

Expert Solution

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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