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eBook The Oviedo Company is considering the purchase of a new machine to replace an obsolete...

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The Oviedo Company is considering the purchase of a new machine to replace an obsolete one. The machine being used for the operation has a book value and a market value of zero. However, the machine is in good working order and will last at least another 10 years. The proposed replacement machine will perform the operation so much more efficiently that Oviedo's engineers estimate that it will produce an increase in after-tax cash flows (labor savings and depreciation) of $6,000 per year. The new machine will cost $35,000 delivered and installed, and its economic life is estimated to be 10 years. It has zero salvage value. The firm's WACC is 10%, and its marginal tax rate is 35%.

Should Oviedo buy the new machine?
Oviedo -Select- (should should not) purchase the new machine.

Solutions

Expert Solution

Time line 0 1 2 3 4 5 6 7 8 9 10
Cost of new machine -35000
=Initial Investment outlay -35000
100.00%
Depreciation Cost of equipment/no. of years -3500 -3500 -3500 -3500 -3500 -3500 -3500 -3500 -3500 -3500 0 =Salvage Value
=after tax operating cash flow 6000.00 6000.00 6000 6000 6000 6000 6000 6000 6000 6000
+Tax shield on salvage book value =Salvage value * tax rate 0
=Terminal year after tax cash flows 0
Total Cash flow for the period -35000 6000 6000 6000 6000 6000 6000 6000 6000 6000 6000
Discount factor= (1+discount rate)^corresponding period 1 1.1 1.21 1.331 1.4641 1.61051 1.771561 1.9487171 2.1435888 2.357948 2.593742
Discounted CF= Cashflow/discount factor -35000 5454.5455 4958.6777 4507.8888 4098.0807 3725.5279 3386.8436 3078.948709 2799.0443 2544.586 2313.26
NPV= Sum of discounted CF= 1867.40

Buy new machine as NPV is positive

jeff jeffy answered 1 year ago
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