Question

One year​ ago, your company purchased a machine used in manufacturing for $ 115,000 . You have learned that a new machine is available that offers many advantages and you can purchase it for $ 170,000 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 $ 35,000 per year for the next 10 years. The current machine is expected to produce a gross margin of $ 22, 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 $ 10,455 per year. The market value today of the current machine is $ 55,000 . 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?

a. The NPV of replacing the​ year-old machine is $__​(Round to the nearest​ dollar)

b. Should your company replace its​ year-old machine?

No, there is a profit loss from replacing

Yes, there is a profit

Answer 1

Based on the given data, pls find below the steps, workings and answers;

- Based on the same, two approaches have been worked out;

Option 1 - to continue with the existing current machine

Option 2 - to replace with the new machine

Have worked out the Free cash flows and NPV based on the same;

NPV of Option 1 is negative and NPV of replacement option is positive $ 62937.55 and hence this is recommended for replacing the curren machine with the new machine as there is profit over the existing one;

Computation of Net Present Value (NPV) based on the Discounted Cash flows; The Discounting factor is computed based on the formula: For year 0, the discounting factor is 1; For Year 1, it is computed as = Year 0 factor /(1+discounting factor%) ; Year 2 = Year 1 factor/(1+discounting factor %) and so on;

Next, the cashflows need to be multiplied with the respective years' discounting factor, to arrive at the discounting cash flows;

The total of all the discounted cash flows is equal to its respective Project NPV of the Cash Flows;