Question

One year ago, your company purchased a machine used in manufacturing for $110,000. You have learned that a new machine is available that offers many advantages; you can purchase it for $150,000 today. It will be depreciated on a straight-line basis over ten years, after which it has no salvage value. You expect that the new machine will contribute EBITDA (earnings before interest, taxes, depreciation, and amortization) of $60,000 per year for the next ten years. The current machine is expected to produce EBITDA of $22,000 per year. The current machine is being depreciated on a straight-line basis over a useful life of 11 years, after which it will have no salvage value, so depreciation expense for the current machine is $10,000 per year. All other expenses of the two machines are identical. The market value today of the current machine is $50,000. Your company's tax rate is 35%, and the opportunity cost of capital for this type of equipment is 10%. Is it profitable to replace the year-old machine? The NPV of the replacement is $nothingm. (Round to the nearest dollar.)

Answer 1

Answer: Depreciation every year for new machine = 150000/10 = 15000

Depreciation every year for Old machine = 110000/11 = 10000

EBITDA, new machine = $60000

EBITDA, Old Machine = $22000

Market Value of old machine = $50000

Book value = $110000 - $10000 = $100000, loss of $50000 on selling it now. it will result in a tax save of 50000*0.35 = $17500

If we buy the new machine incremental benefit would be

	Year 0	year 1-10	Calculation
Revenue	-	-
Operating expenses	-	-
Gross margin	-	38000	(60000-22000)
Dep		5000	(15000-5000)
EBIT		33000	(Gross margin- Dep)
Tax (at 35%)		11550	(EBIT*0.35)
Incremental Earnings		21450	(EBIT - tax)
Add back depreciation		26450	(21450+ 5000)
NWC
Capital expenditure	-82500		(-150000+67500)

FCF = 26450

Calculate the present value of this equation

NPV = -82450 + 26450 * PV(10, 10%)

you can also solve this using present value formula cash flow/(1+interest rate)^ (no of years)

Year	0	1	2	3	4	5	6	7	8	9	10
Cash Flow	-82450	26450	26450	26450	26450	26450	26450	26450	26450	26450	26450
Present value	-82450	24045.45	21859.5	19872.28	18065.70589	16423	14930.33545	13573.03223	12339.12	11217.38	10197.62

NPV = 80,073.8

It is coming out to be positive which means we can opt for the new machine.