The chen company is considering the purchase of a new machine to replace an obso

Question

The chen company is considering the purchase of a new machine to replace an obsolete one. The machine being used for the operation has both a book value and a market value of zero; it is in good working order, however, and will last physically for at least another 10 years. The proposed replacement machine will perform the operation so much more efficiently that Chen%u2019s engineers estimate it will produce after-tax cash flows (labor savings and depreciation) of $9,000 per year. The new machine will cost $40,000 delivered and installed, and its economic life is estimated to be 10 years. It has zero salvage value. The firm%u2019s WACC is 10%, and its marginal tax rate is 35%. Should Chen buy the new machine?

Explanation / Answer

NPV of new machines =-$40,000 +$9,000/1.1 + $9,000/1.1^2 ...$9,000/1.1^10 =$15,301.10 The machine has positive NPV. Chen should buy the new machine.

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