Question

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 that you can purchase it for $160,000 today. The CCA rate applicable to both machines is 20% ​; neither machine will have any​ long-term salvage value. You expect that the new machine will produce earnings before​ interest, taxes,​ depreciation, and amortization​ (EBITDA) of $40,000 per year for the next 10 years. The current machine is expected to produce EBITDA of $22,000 per year. All other expenses of the two machines are identical. The market value today of the current machine is $50,000. Your​ company's tax rate is 40%​, and the opportunity cost of capital for this type of equipment is 12%.

Should your company replace its​ year-old machine? What is the NPV of​ replacement? The NPV of replacement is ​$?. ​(Round to the nearest​ dollar.)

Answer 1

In this question we need find out whether any additional benefit will recieve due the installation of new machine.For that purpose calculate Incremental NPV.If the incremental NPV is positive we can go for new machine.

Financial evaluation of whether to replace Existing machine

Incremental cash outflow

Cost of new machine. 160000

Less:Sale value of old machine. (50000)

Less:Tax saving on loss on sale of old (18000) machine(95000-50000)*40/100

Outflow 92000

incremental cash inflow for year 1 to year 10

Increase in EBITDA. (40000-22000). 18000

Less:Increase in depreciation (160000*20/100)-(95000*20/100). 13000

Profit before tax. 5000

Less:Tax @40/100 2000

3000

Add: Depreciation. 13000

Net Cash inflow after tax. (CFAT) 16000

Computation of Net Present Value

Year	CFAT	PV factor	Total PV
0	(92000)	1	92000
1-10	16000	5.65	90400
		NPV	(1600)

NPV of replacement is 1600 dollar

Since Incremental NPV is negative,the Company is advised not to replace the old machine.