One year ago, your company purchased a machine used in manufacturing for $90,000
ID: 2731442 • Letter: O
Question
One year ago, your company purchased a machine used in manufacturing for $90,000. 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 and has no salvage value. You expect that the new machine will produce a gross margin (revenues minus operating expenses other than depreciation) of $45,000 per year for the next ten years. The current machine is expected to produce a gross margin of $25,000 per year. The current machine is being depreciated on a straight-line basis over a useful life of 11 years, and has no salvage value, so depreciation expense for the current machine is $8.182 per year. The market value today of the current machine is $65,000. Your companys tax rate is 42%, and the opportunity cost of capital for this type of equipment is 10%. Should your company replace its year-old machine?
Explanation / Answer
Depreciation for old machine
Useful life =11 years
$90000/11=8182
WDV of old machine $90000-$8182=$81818
Depreciation
Useful life= 10 years
$170000/10=$17000
Option 1: Continue with old machine
Option 2: Replace for a new machine
Decision: Since, there is an increase in revenues $99788-$59937=$39851, replacement of new machine is recommended.
Notes
1.purchase cost of old machine is irrelevant being a sunk cost.
year gross margin depreciation net margin before tax tax@42% net margin COC@10% discounted margin 1 25000 8182 16818 7064 9754 0.9091 8868 2 25000 8182 16818 7064 9754 0.8264 8062 3 25000 8182 16818 7064 9754 0.7513 7329 4 25000 8182 16818 7064 9754 0.6830 6662 5 25000 8182 16818 7064 9754 0.6209 6057 6 25000 8182 16818 7064 9754 0.5645 5506 7 25000 8182 16818 7064 9754 0.5132 5006 8 25000 8182 16818 7064 9754 0.4665 4551 9 25000 8182 16818 7064 9754 0.4241 4137 10 25000 8182 16818 7064 9754 0.3855 3761 TOTAL 59937Related Questions
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