Question

In: Accounting

Your firm bought a new sanding machine for its factory floor two years ago for $40,000....

Your firm bought a new sanding machine for its factory floor two years ago for $40,000. The current market value (Year 0) of the machine is $10,000 and you believe that it will last 5 more years (Years 1 - 5). When you're done with the machine, you can sell it for scrap and receive $1,000. However, your firm is now considering buying a more advanced sander for $80,000. The more advanced machine also last 5 more years. The new machine will have a salvage value of $5,000. The more advanced sander will increase revenues by $50,000 a year and save the company $10,000 in labor costs each year when compared to the old machine. The appropriate discount rate for this project is 12% and the company's tax rate is 35%. Use straight-line depreciation (including the appropriate salvage values).

What is the NPV of replacing the old machine? Be sure you take into account the sale of the old machine (including the tax consequences of the sale) in Year 0. This problem is really all about carefully calculating the cash flows associated with this decision each year. Build a mini-income statement for each year and then take that income and turn it into free cash flow by taking into account depreciation.

NB: Show excel working formula,p please

Solutions

Expert Solution

Old Machine
Year 0 40000 Depreciation
Year 1 32000 8000
Yaer 2 24000 8000
Year 3 24000 In The Beginning of the Year
Here Considered Zero Salvage value for Depreciation Purpose i.e 40000 - 0 / 5= 8000
Loss on Sale of Old Machine 24000 - 10000 = 14000
Current Market Value 10000
Here Loss is 14000, If this loss is not taken it means we have to pay tax on 14000 X 35% = 4900 due to this loss 4900 will be Cash Inflow
At Year 3 Proposal for Buying New Machine
Year 0 ( Year 3) 80000 Cash Outflow
Life will be 5 Years
Depreciation 80000 - 5000 / = 15000
Analyisis of Cash Inflows
Year 0( Sale of Old Machine) - - - 10000 3500 6500 1 6500
Year 0 ( Saving on Loss of Sale of Old Machine) - - - -14000 -4900 4900 1 4900
Incremental Revenue Savings in Labour Cost Depreciation Net Cash Inflows Tax Rate @ 35% Net Inflow After TA x PV @ 12 %
Year 1 50000 10000 15000 45000 15750 44250 0.8929 39509
Year 2 50000 10000 15000 45000 15750 44250 0.7972 35276
Year 3 50000 10000 15000 45000 15750 44250 0.7118 31496
Year 4 50000 10000 15000 45000 15750 44250 0.6355 28122
Year 5 50000 10000 15000 45000 15750 44250 0.5674 25109
Year 5 ( Salvage) - - - 5000 1750 3250 0.5674 1844
PV Value of Cash Inflows 172755
Cash Ouflows -80000
Net Present Value 92755
Here instead of Presenting Income Statemnet , Refere the table to Understand the Cash inflows.
Income Sttament ( Just for Understanding )
Year 0 Recepts on Sale Of Old 10000
Loss on Sale -14000
Year 1-4
Incremental Revneus 50000

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