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; 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 $ 55,000 per year for the next ten years. The current machine is expected to produce EBITDA of $ 24,000 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 $ 10,455 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?

Answer 1

Capital Budgeting Option 01
Existing machine
Year	EBIT	Depreciation	Profit Before Tax	Tax	Profit After Tax	Cash Out Flow	Cash In Flow	Net Cash Flow	Present Value @10%	Present Value of Cash Flow
											a	b	c	d=b-c	e=d*35%	f=d-e	g	h	i=g-h	j	k=I X K
0	24000	10,455	13,545	4741	8,805	-1,15,000.00		-115000	1	-1,15,000.00
1	24000	10,455	13,545	4741	8805		19259	19259	0.91	17,508.26
2	24000	10,455	13,545	4741	8805		19259	19259	0.83	15,916.60
3	24000	10,455	13,545	4741	8805		19259	19259	0.75	14,469.64
4	24000	10,455	13,545	4741	8805		19259	19259	0.68	13,154.22
5	24000	10,455	13,545	4741	8805		19259	19259	0.62	11,958.38
6	24000	10,455	13,545	4741	8805		19259	19259	0.56	10,871.25
7	24000	10,455	13,545	4741	8805		19259	19259	0.51	9,882.96
8	24000	10,455	13,545	4741	8805		19259	19259	0.47	8,984.51
9	24000	10,455	13,545	4741	8805		19259	19259	0.42	8,167.73
10	24000	10,455	13,545	4741	8805		19259	19259	0.39	7,425.21
	Net Present Value									3,338.78
Capital Budgeting Option 02
Purchase of new Machine
Year	EBIT	Depreciation	Profit Before Tax	Tax	Profit After Tax	Cash Out Flow1	Cash In Flow	Net Cash Flow	Present Value @10%	Present Value of Cash Flow
											a	b	c	d=b-c	e=d*35%	f=d-e	g	h	i=g-h	j	k=I X K
1	55000	15000	40000	14000	26000	-1,00,000.00	41000	-59000	1.00	-59,000.00
2	55000	15000	40000	14000	26000		41000	41000	0.91	37,272.73
3	55000	15000	40000	14000	26000		41000	41000	0.83	33,884.30
4	55000	15000	40000	14000	26000		41000	41000	0.75	30,803.91
5	55000	15000	40000	14000	26000		41000	41000	0.68	28,003.55
6	55000	15000	40000	14000	26000		41000	41000	0.62	25,457.77
7	55000	15000	40000	14000	26000		41000	41000	0.56	23,143.43
8	55000	15000	40000	14000	26000		41000	41000	0.51	21,039.48
9	55000	15000	40000	14000	26000		41000	41000	0.47	19,126.80
10	55000	15000	40000	14000	26000		41000	41000	0.42	17,388.00
	Net Present Value									1,77,119.98
	Note 1	Cash outflow is net of sale proceeds of old machine 50000 and purchase of new machine 150000
	Conclusion:- It is better to replace old machine.