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In: Finance

One year​ ago, your company purchased a machine used in manufacturing for $ 110 comma 000....

One year​ ago, your company purchased a machine used in manufacturing for $ 110 comma 000. You have learned that a new machine is available that offers many advantages and you can purchase it for $ 150 comma 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 comma 000 per year for the next 10 years. The current machine is expected to produce a gross margin of $ 20 comma 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 comma 000 per year. The market value today of the current machine is $ 50 comma 000. Your​ company's tax rate is 45 %​, and the opportunity cost of capital for this type of equipment is 10 %. Should your company replace its​ year-old machine?

The NPV of replacing the​ year-old machine is $

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Expert Solution

Old Machine (1 year old) New Machine
A B
Original Cost of old Machine 110000
Sl. No. Particulars Amount Amount
1 Market Value 50000 150000
2 Life of the Machine 11 years 10 years
3 Salvage Value 0 0
4 Depreciation Rate 9.09% 10%
5 Annual Depreciation (Cost * Depreciation Rate) 10000 15000
6 Gross Margin 20000 40000
7 Gross Margin after Depreciation (6-5) 10000 25000
8 Tax Rate 45% 45%
9 Net Margin (After (Tax) = Gross Margin after Depreciation * (1- tax rate) 5500 13750
8 Opportunity Cost of Capital 10% 10%
Incremental Cost of New Machine After considering that the old Machine will be sold for $ 50,000 = $150000 - $ 50000
= $ 1,00,000
Incremental Cash inflow after Tax i.e. Net Margin = 13750 - 5500 8250
Present Value of incremental Cash inflow after Tax i.e. Net Margin PV factor = 61.44567 ₹ 84,487.80
NPV = Incremental Cost of New Machine After considering that the old Machine will be sold for $ 50,000 - Present Value of incremental Cash inflow after Tax i.e. Net Margin = 84487.80 - 100000 ₹ -15,512.20
NPV = - $15512
Since the NPV of incremental Cash Flow is negative, the company should not replace the yearlong old machine

jeff jeffy answered 1 year ago
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