One year ago, your company purchased a machine used in manufacturing for $105,00
ID: 2782090 • Letter: O
Question
One year ago, your company purchased a machine used in manufacturing for $105,000. You have learned that a new machine is available that offers many advantages; you can purchase it for $150,000 today. It will be depreciated on a straight-line basis over ten years, after which it has no salvage value. You expect that the new machine will contribute EBITDA (earnings before interest, taxes, depreciation, and amortization) of $45,000 per year for the next ten years. The current machine is expected to produce EBITDA of $21,000 per year. The current machine is being depreciated on a straight-line basis over a useful life of 11 years, after which it will have no salvage value, so depreciation expense for the current machine is $9,545 per year. All other expenses of the two machines are identical. The market value today of the current machine is $50,000. Your company's tax rate is 35%, and the opportunity cost of capital for this type of equipment is 11%. Is it profitable to replace the year-old machine? What is the NPV?
Explanation / Answer
There is replacemnet of old machine with new one, so we will use incremental approach for calculation of NPV. if The incremental NPV will be positive then it willbe profitable to replace the old machine otherwise not.
Calculation of Incremental Initial Investment:
Sale value of old machine= $ 50000
Book value today( 105000-9455)= $ 95455
Loss= ( 50000-95455)= - $ 45455
Tax savings= 35 % of 45455= $ 15909
Post tax salvage value= 50000+ 15909= $ 65909
Therefore Incremental initial investment= 150000-65909= $ 84091
Calculation of Operating Cashflows:($)
Incremental EBITDA( 45000-21000) 24000
less: Incremenatl Depriciation( 15000-9545) 5455
EBIT 18545
Tax EXpenses: ( 35% of 18545) 6490.75
NOPAT 12054.25
Add: Depn 5455
incremental operating cashflows 17509.25
There is no information of terminal cashflows in the question
Calculation of INcremental cashflows
NPV = PV of incremental inflows- Incremental Initial investment
PV of incremental inflows
using BA II PLUS calculator
17509.25 PMT, 10N, 11 I/Y, CPT PV
PV = $ 103116.04
NPV = (103116.04-84091)= $ 19025.04( justified)
We should replace the old machine.
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