Question

One year​ ago, your company purchased a machine used in manufacturing for

$ 115,000

You have learned that a new machine is available that offers many advantages and you can purchase it for

$ 160,000

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

$ 50,000

per year for the next 10 years. The current machine is expected to produce a gross margin of

$ 25,000

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

$10,455

per year. The market value today of the current machine is

$45,000.

Your​ company's tax rate is

38%​,

and the opportunity cost of capital for this type of equipment is

10%.

Should your company replace its​ year-old machine?

Answer 1

Answer to the Question
Details of old Asset
Cost of old asset = $ 115000
Current Book value = Cost - Depreciation ($ 115000- $ 10455)
	$104545
Remaining Useful life = 10 yrs
Present Sale Value = $ 45000
New Asset
Initial Investment = Cost of New Machine - Sale of old Machine - Tax benefit on Capital Loss of Sale of old machine
	i.e = 160000 - 45000 - 22627 (115000-45000)*.38
		Therefore cost of new machine =	92373.00
Subsequent Cash flow
		Gross Margin of new machine	50000.00
		Less: Gross Margin of Old Machine	25000.00
		Incremental Margin	25000.00
		Less: Additional Depreciation	5545.00	(16000-10455)
		Profit After Depreciation	19455.00
		Less Tax @ 38 %	7392.90
		Profit After Tax	12062.10
		add : Additional Depreciation	5545.00
		Incremental Cash flow	17607.10
Present Value of Incremental Cash flow
Year	Cash flow	Present value annuity factor @ 10 % for 10 yrs	Present Value
0	-92373.0	1	-92373.00
1 to 10	17607.1	6.1445	108186.83
		Net present value	15813.83
Decision: Net present value of Incremental cash flow is favorable and the old machine can be replaced.