The Chang Company is considering the purchase of a new machine to replace an obs

Question

The Chang 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 at least another 5 years. The proposed replacement machine will perform the operation so much more efficiently that Chang’s engineers estimate that it will produce after-tax cash flows (labor savings and depreciation) of $10,500 per year. The new machine will cost $31,500 delivered and installed, and its economic life is estimated to be 5 years. It has zero salvage value. The firm’s WACC is 6.00%, and its marginal tax rate is 40%. Calculate the NPV of the replacement analysis?

Explanation / Answer

Calculation of NPV:

Initial Cash Outflow:

Cost of new machine = -$31500

Recurring Cash Flows:

After Tax Cash Flows = $10500

Year

Cash Flow

PVF (6%)

PV of Cash Flow

0

-$31500

1

-$31500

1-5

$10500

4.21236

$44229.78

$12729.78

NPV of replacement analysis = $12729.78

Year

Cash Flow

PVF (6%)

PV of Cash Flow

0

-$31500

1

-$31500

1-5

$10500

4.21236

$44229.78

$12729.78

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