Question

In: Finance

One year​ ago, your company purchased a machine used in manufacturing for $ 100,000. You have...

One year​ ago, your company purchased a machine used in manufacturing for $ 100,000. You have learned that a new machine is available that offers many​ advantages; you can purchase it for $ 170,000 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 $ 35,000 per year for the next ten years. The current machine is expected to produce EBITDA of $ 21,000 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 $ 9,091 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 38 %​, and the opportunity cost of capital for this type of equipment is 10 %. Is it profitable to replace the​ year-old machine?

Solutions

Expert Solution

Answer:

No.

It is not profitable to replace the​ year-old machine.

The NPV of replacement project is negative and is = - $32,652.73

Working:

Annual Depreciation of current machine =$9,091

Book value of current machine = $100,000 - $9,091 = $90,909

Market value = $50,000

Loss on sale = $90,909 -$50,000 = $40,909

Tax on loss = $40,909 * 38% = $15,545.42

NPV of replacement is calculated below:


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