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?
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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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