Question
In: Finance
One year ago, your company purchased a machine used in manufacturing for $95,000. You have learned...
One year ago, your company purchased a machine used in manufacturing for $95,000. You have learned that a new machine is available that offers many advantages and you can purchase it for $165,000 today. 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 $40,000 per year for the next 10 years. The current machine is expected to produce a gross margin of $22,000 per 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 $8,636 per year. The market value today of the current machine is $50,000. Your company's tax rate is 42%,and the opportunity cost of capital for this type of equipment is 11%. Should your company replace its year-old machine?
Solutions
Expert Solution
book value of old equipment
| Book value = (purchase price)*remaining life/total life | |
| = (95000)*10/11 | |
| = 86363.64 | |
| Time line | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | |
| Proceeds from sale of existing asset | =selling price* ( 1 -tax rate) | 29000 | ||||||||||
| Tax shield on existing asset book value | =Book value * tax rate | 36272.7288 | ||||||||||
| Cost of new machine | -165000 | |||||||||||
| =Initial Investment outlay | -99727.2712 | |||||||||||
| Profits | 18000 | 18000 | 18000 | 18000 | 18000 | 18000 | 18000 | 18000 | 18000 | 18000 | ||
| -Depreciation | Cost of equipment/no. of years | -16500 | -16500 | -16500 | -16500 | -16500 | -16500 | -16500 | -16500 | -16500 | -16500 | |
| =Pretax cash flows | 1500 | 1500 | 1500 | 1500 | 1500 | 1500 | 1500 | 1500 | 1500 | 1500 | ||
| -taxes | =(Pretax cash flows)*(1-tax) | 870 | 870 | 870 | 870 | 870 | 870 | 870 | 870 | 870 | 870 | |
| +Depreciation | 16500 | 16500 | 16500 | 16500 | 16500 | 16500 | 16500 | 16500 | 16500 | 16500 | ||
| =after tax operating cash flow | 17370 | 17370 | 17370 | 17370 | 17370 | 17370 | 17370 | 17370 | 17370 | 17370 | ||
| +Tax shield on salvage book value | =Salvage value * tax rate | 0 | ||||||||||
| =Terminal year after tax cash flows | 0 | |||||||||||
| Total Cash flow for the period | -99727.2712 | 17370.00 | 17370.0000 | 17370.00 | 17370 | 17370 | 17370 | 17370 | 17370 | 17370 | 17370 | |
| Discount factor= | (1+discount rate)^corresponding period | 1 | 1.11 | 1.2321 | 1.367631 | 1.5180704 | 1.6850582 | 1.8704146 | 2.07616 | 2.3045378 | 2.558037 | 2.839421 |
| Discounted CF= | Cashflow/discount factor | -99727.2712 | 15648.64865 | 14097.88167 | 12700.79429 | 11442.157 | 10308.25 | 9286.7113 | 8366.407 | 7537.3032 | 6790.363 | 6117.444 |
| NPV= | Sum of discounted CF= | 2568.688834 | ||||||||||
Buy new machine as NPV is positive
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before? interest, taxes,? depreciation, and amortization
(EBITDA?) of $50,000 per year for the next ten years. The
current machine...
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