Question

XYZ purchased a machine 5 years ago at a cost of $95,000. The machine had an expected life of 10 years at the time of purchase, and it is being depreciated by the straight-line method by $9,500 per year. If the machine is not replaced, it can be sold for $11,000 at the end of its useful life. A new machine can be purchased for $170,000, including installation costs. During its 5-year life, it will reduce cash operating expenses by $55,000 per year. Sales are not expected to change. At the end of its useful life, the machine is estimated to be worthless. MACRS depreciation will be used and the machine will be depreciated over its 3-year class life rather than its 5-year economic life; so the applicable depreciation rates are 33%, 45%, 15%, and 7%. The old machine can be sold today for $65,000. The firm's tax rate is 45%. The appropriate WACC is 17%.

a. If the new machine is purchased, what is the amount of the initial cash flow at Year 0?

b. What are the incremental cash flows that will occur at the end of Years 1 through 5?

c. What is the NPV of this project? Should the old machine be replaced? Explain.

Please mention the keys step by step that were used so I can solve it, ON FINANCIAL CALCULATOR BA II PLUS, otherwise your solution is of no value! NO EXCEL ANSWERS!

Answer 1

If new machine is purchase

A)    Initial cash flow at year 0

Cost of new machine.                    $170000

Less- Proceed from old machine. (65000)

tax on gain on sale of old machine 7875

Initial out flow                                   112875

Annual cash flow

B)Annual saving = 55000

Less tax @45%=24750

Net annual saving =30250

Increase in depreciation (schedule )

Total annual benefit present value (schedule)

So present value of annual saving is 139850$

C) calculation of npv

Terminal cash flow

Opportunity loss to sell old assets =11000
Less tax (book value would have 0 =(4950)

Net cach flow loss due to new asset=6050

Pv factor of 5 year.                             .4561

Present value. (Net outflow)           2760$

Present value of Annual cash flow	139850
Less - initial incremental out flow	(112875)
Less - terminal out flow (opportunity loss)	(2760)
Net cash flow inflow (Npv)	24215$

So net incremental npv of new machine is positive .i.e. 24215$

Different in answer could be due to tax consideration on capital gains i.e (sale value -book value)

Depreciated book value of old machine

(95000-(9500*5)) =47000 sold for 65000

Capital gain=17500

Tax on that @45 % 7875.

But some other authors has different point of view like normal tax rate and capital gains tax rate are different so should not considered capital gains until questions specifically tell. And some has another point of view to consider.

I have provided u both solution u can consider as per your books