Question

In: Finance

One year ago your company purchased a machine used in manufacturing for $115,000. You have learned...

One year ago your company purchased a machine used in manufacturing for $115,000. You have learned that q new machine is available that offers many advantages and you can purchase it for $150,000 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 $55,000 per year for the next 10 years. The current machine is expected to produce a gross margin of $24,000 per year. The current machine is being depreciated on 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 $65,000. Your company's tax rate is 40%, and the opportunity cost of capital for this type of equipment is 11%. Should your company replace its year- old machine?

Solutions

Expert Solution

Summary
NPV of new machine $        79,680.05
NPV of old machine $        44,433.71

Replace the machine:

NPV of old machine:

Ref Particulars Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
a Operating cash flow $          24,000.00 $               24,000.00 $        24,000.00 $        24,000.00 $        24,000.00 $        24,000.00 $        24,000.00 $        24,000.00 $        24,000.00 $         24,000.00
Salvage value
b Depreciation $        (10,455.00) $             (10,455.00) $      (10,455.00) $      (10,455.00) $      (10,455.00) $      (10,455.00) $      (10,455.00) $      (10,455.00) $      (10,455.00) $       (10,455.00)
c=a-b Profit before tax $          13,545.00 $               13,545.00 $        13,545.00 $        13,545.00 $        13,545.00 $        13,545.00 $        13,545.00 $        13,545.00 $        13,545.00 $         13,545.00
Profit after tax $            8,127.00 $                 8,127.00 $          8,127.00 $          8,127.00 $          8,127.00 $          8,127.00 $          8,127.00 $          8,127.00 $          8,127.00 $           8,127.00
Add depreciation $          10,455.00 $               10,455.00 $        10,455.00 $        10,455.00 $        10,455.00 $        10,455.00 $        10,455.00 $        10,455.00 $        10,455.00 $         10,455.00
Add: working capital
Free cash flow $          18,582.00 $               18,582.00 $        18,582.00 $        18,582.00 $        18,582.00 $        18,582.00 $        18,582.00 $        18,582.00 $        18,582.00 $         18,582.00
d Present value factor@ 11.0% 0.900900901 0.811622433 0.731191381 0.658730974 0.593451328 0.534640836 0.481658411 0.433926496 0.390924771 0.352184479
e=c*d Present value of annual cashflows $          16,740.54 $               15,081.57 $        13,587.00 $        12,240.54 $        11,027.51 $          9,934.70 $          8,950.18 $          8,063.22 $          7,264.16 $           6,544.29
Total present value of annual cash inflows $       1,09,433.71
Investment:
Equipment $        (65,000.00)
Working capital $                        -  
NPV $          44,433.71

NPV of new machine

Ref Particulars Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
a Operating cash flow $          55,000.00 $               55,000.00 $        55,000.00 $        55,000.00 $        55,000.00 $        55,000.00 $        55,000.00 $        55,000.00 $        55,000.00 $         55,000.00
Salvage value
b Depreciation $        (15,000.00) $             (15,000.00) $      (15,000.00) $      (15,000.00) $      (15,000.00) $      (15,000.00) $      (15,000.00) $      (15,000.00) $      (15,000.00) $       (15,000.00)
c=a-b Profit before tax $          40,000.00 $               40,000.00 $        40,000.00 $        40,000.00 $        40,000.00 $        40,000.00 $        40,000.00 $        40,000.00 $        40,000.00 $         40,000.00
Profit after tax $          24,000.00 $               24,000.00 $        24,000.00 $        24,000.00 $        24,000.00 $        24,000.00 $        24,000.00 $        24,000.00 $        24,000.00 $         24,000.00
Add depreciation $          15,000.00 $               15,000.00 $        15,000.00 $        15,000.00 $        15,000.00 $        15,000.00 $        15,000.00 $        15,000.00 $        15,000.00 $         15,000.00
Add: working capital $                        -   $                             -   $                      -   $                      -   $                      -   $                      -   $                      -   $                      -   $                      -   $                       -  
Free cash flow $          39,000.00 $               39,000.00 $        39,000.00 $        39,000.00 $        39,000.00 $        39,000.00 $        39,000.00 $        39,000.00 $        39,000.00 $         39,000.00
d Present value factor@ 11.0% 0.900900901 0.811622433 0.731191381 0.658730974 0.593451328 0.534640836 0.481658411 0.433926496 0.390924771 0.352184479
e=c*d Present value of annual cashflows $          35,135.14 $               31,653.27 $        28,516.46 $        25,690.51 $        23,144.60 $        20,850.99 $        18,784.68 $        16,923.13 $        15,246.07 $         13,735.19
Total present value of annual cash inflows $       2,29,680.05
Investment:
Equipment $     (1,50,000.00)
Working capital $                        -  
NPV $          79,680.05

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