Question

One year​ ago, your company purchased a machine used in manufacturing for $ 100000. You have learned that a new machine is available that offers many advantages and you can purchase it for $ 160000 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 $ 45000 per year for the next 10 years. The current machine is expected to produce a gross margin of $ 22000 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 $ 9091 per year. The market value today of the current machine is $ 60000. Your​ company's tax rate is 38%​, and the opportunity cost of capital for this type of equipment is 12 %. Should your company replace its​ year-old machine?

Answer 1

Tax rate		38%
Calculation of after-tax salvage value
Cost of machine			$ 100,000
Depreciation			$ 90,91
WDV			$ 90,909
Sale price			$ 60,000
Profit/(Loss)			$ (30,909)
Tax			$ (11,745)
Sale price after-tax			$ 71,745
Calculation of initial investment
Cost of new machine			$ 160,000
After tax sale price of old machine			$ (71745)
Initial investment			$ 88,255
Calculation of additional depreciation
		Old Machine	New Machine
Cost		$ 100,000	$ 160,000
Useful life		11.00	10.00
Annual Depreciation-Cost/Life		$ 90,91	$             16,000
Additional depreciation		16000-9091
Additional depreciation		$                                               6,909
Calculation of annual incremental operating cash flow
		Year-1-10
Revenue from new machine		$ 45,000
Less: Revenue from old machine		$             22,000
Contribution		$             23,000
Less: Incremental depreciation		$                6,909
Profit before tax		$ 16,091
Tax@38%		$ 6,115
Profit After Tax		$ 9,976
Add Depreciation		$ 6,909
Cash Profit after-tax		$ 16,885
Calculation of NPV
						10.00%
Year		Capital		Operating cash	Annual Cash flow	PV factor	Present values
0		$            (88,255)			$            (88,255)	1.0000	$            (88,255)
1				$             16,855	$             16,855	0.9091	$             15,323
2				$             16,855	$             16,855	0.8264	$             13,929
3				$             16,855	$             16,855	0.7513	$             12,663
4				$             16,855	$             16,855	0.6830	$             12,850
5				$             16,855	$             16,855	0.6209	$             11,512
6				$             16,855	$             16,855	0.5645	$ 9,515
7				$             16,855	$             16,855	0.5132	$ 8,650
8				$             16,855	$             16,855	0.4665	$ 7,863
9				$             16,855	$             16,855	0.4241	$                7,148
10		$                      -		$             16,855	$             16,855	0.3855	$ 6,497

Net Present Value of replaced machine

$ $17,689