One year ago, your company purchased a machine used in manufacturing for$105,000.You have learned that a...

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?

Expert Solution

	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.

jeff jeffy answered 1 year ago

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