One year ago, your company purchased a machine used in manufacturing for $90,000
ID: 2800076 • 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, after which it has no salvage value. You expect that the new machine will contribute EBITDA (earnings before interest, taxes, depreciation, and amortization) of $40,000 per year for the next ten years. The current machine is expected to produce EBITDA of $24,000 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 $8,182 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 40%, and the opportunity cost of capital for this type of equipment is 11%.
The NPV of the replacement is $________________
Is it profitable to replace the year-old machine?
Explanation / Answer
A / 1 B C D E 2 Particulars Existing machine new machine 3 EBITDA $24,000 $40,000 4 Investment cost(previous year bought) $90,000 $170,000 5 useful life years 11 10 6 Depreciation straightline $8,182 $17,000 7 EBT $15,818 $23,000 8 Less:Taxes @40% $6,327 $9,200 9 Net Income $9,491 $13,800 10 net operating cash flow(Net income+Depn) $17,673 $30,800 11 Cost of capital 11% 11% 12 Remaining life in years 10 10 13 Present value of 10 years cash inflow $104,079 $181,388 =-PV(D11,D12,D10,0,0) 14 Net Present Value of the new machine $11,388 15 16 If we sell the existing machine now for $50,000 17 Cash inflow $50,000 18 Present value last year bought machine $82,227 =FV(C11,1,C20,-C19,0) 19 Investment cost(previous year bought) $90,000 20 net operating cash flow(Net income+Depn) $17,673 21 Loss in selling the existing machine now $32,227 =C18-C17 22 23 The net present value of replacement: 24 NPV of new machine $11,388 25 (Loss)/profit in selling the existing machine now -$32,227 26 The net present value of replacement= -$20,839 =C25+C24 27 28 Hence instead of replacing the old machine, we can use the existing machine it self and the same will give the company NPV of $21,852 =C13-C18
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