Question
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 $
Solutions
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 agoRelated Solutions
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