One year ago, your company purchased a machine used in manufacturing for $115,00

Question

One year ago, your company purchased a machine used in manufacturing for $115,000. You have learned that a new machine is available that offers many advantages and you can purchase it for $165,000 today. It will be deprecated on a straight line basis over 10 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 $55,000 per year for the next 50 years. The current machine is expected to produce a gross margin of $21,000 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 expenses for the current machine is $10,455 per year. The market value today of the current machine is $60,000. Your company's tax rate is 42% and the opportunity cost of capital for this type of equipments is 10%. Should your company replace its year-old machine? The NPV of replacing the year-old machine is

Explanation / Answer

New machine Old machine Net Net Gross mArgin 55000 21000 34000 Net Depreciation 16500 10454.55 6045.45 Book value of Old machine 104545.45 Market Value 60000 Cost of new nachine 165000 cashflows to by new machine 105000 Tax benefit ( As book value > market value) 18709.09 Net Cash flows 86290.91 Year 0 1 2 3 4 5 6 7 8 9 10 Initial cashflows -86290.91 Net Gross margin 34000.00 34000.00 34000.00 34000.00 34000.00 34000.00 34000.00 34000.00 34000.00 34000.00 Depreciation 6045.45 6045.45 6045.45 6045.45 6045.45 6045.45 6045.45 6045.45 6045.45 6045.45 EBIT 27954.55 27954.55 27954.55 27954.55 27954.55 27954.55 27954.55 27954.55 27954.55 27954.55 Tax 11740.91 11740.91 11740.91 11740.91 11740.91 11740.91 11740.91 11740.91 11740.91 11740.91 PAT 16213.64 16213.64 16213.64 16213.64 16213.64 16213.64 16213.64 16213.64 16213.64 16213.64 PAT + Depreciation 22259.09 22259.09 22259.09 22259.09 22259.09 22259.09 22259.09 22259.09 22259.09 22259.09 Total casfflows -86290.91 22259.09 22259.09 22259.09 22259.09 22259.09 22259.09 22259.09 22259.09 22259.09 22259.09 NPV 45,892.34

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