In: Finance
One year ago, your company purchased a machine used in manufacturing for$105,000.You have learned that a new machine is available that offers many advantages and you can purchase it for$140,000today. 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$35,000per year for the next 10 years. The current machine is expected to produce a gross margin of$21,000per 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$9,545per year. The market value today of the current machine is$45,000.Your company's tax rate is40%,and the opportunity cost of capital for this type of equipment is12%.Should your company replace its year-old machine?
0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | |
Gross margin from new machine | 35000 | 35000 | 35000 | 35000 | 35000 | 35000 | 35000 | 35000 | 35000 | 35000 | |
Gross margin lost of current machine | -21000 | -21000 | -21000 | -21000 | -21000 | -21000 | -21000 | -21000 | -21000 | -21000 | |
Depreciation on new machine (140000/10) | -14000 | -14000 | -14000 | -14000 | -14000 | -14000 | -14000 | -14000 | -14000 | -14000 | |
Depreciation on current machine | 9545 | 9545 | 9545 | 9545 | 9545 | 9545 | 9545 | 9545 | 9545 | 9545 | |
Income before tax | 9545 | 9545 | 9545 | 9545 | 9545 | 9545 | 9545 | 9545 | 9545 | 9545 | |
Less: Tax @ 40% | -3818 | -3818 | -3818 | -3818 | -3818 | -3818 | -3818 | -3818 | -3818 | -3818 | |
Net Income | 5727 | 5727 | 5727 | 5727 | 5727 | 5727 | 5727 | 5727 | 5727 | 5727 | |
Add: Net Depreciation (14000 - 9545) | 4455 | 4455 | 4455 | 4455 | 4455 | 4455 | 4455 | 4455 | 4455 | 4455 | |
Operating cash flow | 10182 | 10182 | 10182 | 10182 | 10182 | 10182 | 10182 | 10182 | 10182 | 10182 | |
Sale value of old current machine today | 45000 | ||||||||||
Tax shield on loss on sale of old machine (105000-9545-45000)*0.40 | 20182 | ||||||||||
Cost of new machine | -140000 | ||||||||||
Net cash flow | -74818 | 10182 | 10182 | 10182 | 10182 | 10182 | 10182 | 10182 | 10182 | 10182 | 10182 |
Discount factor @12% | 1 | 0.893 | 0.797 | 0.712 | 0.636 | 0.567 | 0.507 | 0.452 | 0.404 | 0.361 | 0.322 |
PV | -74818 | 9092.53 | 8115.05 | 7249.58 | 6475.75 | 5773.19 | 5162.27 | 4602.26 | 4113.53 | 3675.70 | 3278.60 |
NPV of replacing the year old machine | -17279.5 |
As NPV is negative, company should not replace its year-old machine.