Question

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 $

Answer 1

		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