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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?

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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 2 years ago
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