Question

A firm is considering purchasing a machine that costs
$55,000. It will be used for six years, and the salvage value at
that time is expected to be zero. The machine will save
$25,000 per year in labor, but it will incur $7,000 operating
and maintenance costs each year. The machine will be
depreciated according to six years straight line method. The
firm’s tax rate is 40% and its after-tax MARR is 15%. Should
the machine be bought?

Answer 1

The purchasing decision depends on the NPV of the machine.

If the NPV is positive, the machine should be bought; otherwise should be declined.

SL depreciation (D) = (Cost – Salvage value) / Life years

                           = (55,000 – 0) / 6

                           = 55,000 / 6

                           = 9,167

Net savings (NS) = Savings – Operating cost – Depreciation

Table

Year	D	NS	NS after tax (NAT)	CF = NAT + D
1	9167	25000-7000-9167 = 8833	8833 × (1 – 0.40) = 5299.8	5299.8 + 9,167 = 14,466.8
2	9167	8833	5299.8	14,466.8
3	9167	8833	5299.8	14,466.8
4	9167	8833	5299.8	14,466.8
5	9167	8833	5299.8	14,466.8
6	9165	25000-7000-9165 = 8835	8835 × (1 – 0.40) = 5301	5301 + 9,165 = 14,466
	55,000

Now, NPV is done through Excel.

Answer: Since NPV is positive, the machine should be bought.