A firm is considering purchasing a machine that costs ?$59,000. It will be used

Question

A firm is considering purchasing a machine that costs ?$59,000. It will be used for six? years, and the salvage value at that time is expected to be zero. The machine will save ?$31,000 per year in? labor, but it will incur ?$11,000 in operating and maintenance costs each year. The machine will be depreciated according to? five-year MACRS. The? firm's tax rate is 35?%, and its? after-tax MARR is 11?%. Should the machine be? purchased?

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Explanation / Answer

Solution:

Net present value = Present value of cash inflows - Cost of machine

= $70,594 - $59,000 = $11,594

As NPV is positive, therefore machine should be purchased.

Computation of Present value of cash inflows Particualrs Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Total Saving in labor cost $31,000.00 $31,000.00 $31,000.00 $31,000.00 $31,000.00 $31,000.00 Less: Operating and maintenance cost $11,000.00 $11,000.00 $11,000.00 $11,000.00 $11,000.00 $11,000.00 Less: depreciation $11,800.00 $18,880.00 $11,328.00 $6,796.80 $6,796.80 $3,398.40 Net Increase (Decrease) in income $8,200.00 $1,120.00 $8,672.00 $13,203.20 $13,203.20 $16,601.60 Income Tax (35%) $2,870.00 $392.00 $3,035.20 $4,621.12 $4,621.12 $5,810.56 Net increase in income after tax $5,330.00 $728.00 $5,636.80 $8,582.08 $8,582.08 $10,791.04 Add: depreciation $11,800.00 $18,880.00 $11,328.00 $6,796.80 $6,796.80 $3,398.40 Annual Cash Inflows $17,130.00 $19,608.00 $16,964.80 $15,378.88 $15,378.88 $14,189.44 PV Factor 0.9009 0.8116 0.7312 0.6587 0.5935 0.5346 Present value of cash inflows $15,432.42 $15,913.85 $12,404.66 $10,130.07 $9,127.37 $7,585.67 $70,594.04

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