Question

The Oviedo Company is considering the purchase of a new machine to replace an obsolete one. The machine being used for the operation has a book value and a market value of zero. However, the machine is in good working order and will last at least another 10 years. The proposed replacement machine will perform the operation so much more efficiently that Oviedo's engineers estimate that it will produce after-tax cash flows (labor savings and depreciation) of $9,000 per year. The new machine will cost $45,000 delivered and installed, and its economic life is estimated to be 10 years. It has zero salvage value. The firm's WACC is 10%, and its marginal tax rate is 35%.

Should Oviedo buy the new machine? Oviedo (Should or Should not) purchase the new machine.

Select Should or Should Not

Answer 1

Net Present Value (NPV) of the Project

Year	Annual cash flows ($)	Present Value Factor (PVF) at 10.00%	Present Value of annual cash flows ($) [Annual cash flow x PVF]
1	9,000	0.826446	7,438.02
2	9,000	0.751315	6,761.83
3	9,000	0.683013	6,147.12
4	9,000	0.620921	5,588.29
5	9,000	0.564474	5,080.27
6	9,000	0.513158	4,618.42
7	9,000	0.466507	4,198.57
8	9,000	0.424098	3,816.88
9	9,000	0.385543	3,469.89
10	9,000	0.826446	7,438.02
TOTAL		55,301.10

The Net Present Value (NPV) of the Project = Present Value of annual cash inflows – Initial Investment

= $55,301.10 - $45,000

= $ 10,301.10

DECISION

Oviedo SHOULD buy the new machine, since it has the Positive NPV of $10,301.10.

NOTE    

The Formula for calculating the Present Value Factor is [1/(1 + r)n], Where “r” is the Discount/Interest Rate and “n” is the number of years.