after-tax saivage value The Oviedo Company is considering the purchase of a new
ID: 2791810 • Letter: A
Question
after-tax saivage value The Oviedo Company is considering the purchase of a new REPLACEMENT ANALYSIS 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 10 years. The proposed replacement machine will perform the operation so much more efficiently that Oviedo's engineers estimate that it will produce after-tax cash flows (labor savings and depreciation) of $8,000 per year. The new 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 Oviedo buy the new machine? 12-4Explanation / Answer
OPERATING CASH INFLOWS FOR 10 YEARS
after tax cashflows= 8000
(after depreciation)
add: depreciation = 4500 (note: depreciation = $45000/10 years)
after tax cash inflow = 12500
present value of after tax cash inflow= 12500 * present value interest factor of an annuity for 10 yrs at 10%(since WACC=10%)
= 12500 * 6.145 = $76813
initial investm ent= $45000
Net present value = 76813-45000= $31813
since net present value is positive , the company should buy the machine
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