The Shea Company is considering the purchase of a new machine to replace an obso
ID: 2728085 • Letter: T
Question
The Shea Company is considering the purchase of a new machine to replace an obsolete one. The machine being used for the operation has a book value and a market value of zero. However, the machine is in good working order and will last for another 10 years. The proposed replacement machine will perform the operation so much for efficiently that Shea’s engineers estimate that it will produce after-tax cash flows (labor savings and depreciation) of $8,000 per year. The newer machine will cost $45,000 delivered and installed, and its economic life is estimated to be 10 years. It has zero salvage value. The firm’s WACC is 10%, and its marginal tax rate is 35%. Should Shea Company buy the new machine?
Explanation / Answer
After-tax cash flows = $ 8000
Initial Investment = $ 45000
t = 10 years
Discount Rate = 10%
NPV of new machine = 8000 * PVIFA(10%,10years) - Initial Investment
NPV of new Machine = 8000 * 6.145 - 45000
NPV of new Machine = 49160 - 45000
NPV of new Machine = $4160
Answer: Company should buy the machine since NPV is positive
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