Question

Although the Chen Company's milling machine is old, it is still in relatively good working order and would last for another 10 years. It is inefficient compared to modern standards, though, and so the company is considering replacing it. The new milling machine, at a cost of $38,000 delivered and installed, would also last for 10 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $8,600 per year. It would have zero salvage value at the end of its life. The Project cost of capital is 11%, and its marginal tax rate is 35%.
Should Chen buy the new machine?

Answer 1

Here, the Investment Decision can be taken based on the Net Present Value (NPV) of the Project, The Project should be accepted if the NPV is Positive, else, Reject the Project

Net Present Value (NPV) of the Project

Year	Annual Cash Inflow ($)	Present Value factor at 11%	Present Value of Annual Cash Inflow ($)
1	8,600	0.900901	7,747.75
2	8,600	0.811622	6,979.95
3	8,600	0.731191	6,288.25
4	8,600	0.658731	5,665.09
5	8,600	0.593451	5,103.68
6	8,600	0.534641	4,597.91
7	8,600	0.481658	4,142.26
8	8,600	0.433926	3,731.77
9	8,600	0.390925	3,361.95
10	8,600	0.352184	3,028.79
TOTAL			50,647.40

Net Present Value = Present value of annual cash inflows – Initial investment cost

= $50,647.40 - $38,000

= $12,647.40

DECISION

"YES, The Chen Company should buy the new machine since the Net Present Value (NPV) from the new machine is Positive $12,647.40 and therefore, the New Machine should be purchased.

NOTE

The formula for calculating the Present Value Inflow Factor (PVIF) is [1 / (1 + r)ⁿ], where “r” is the Discount Rate/Cost of capital and “n” is the number of years.