One year ago your company purchased a machine used in manufacturing for $90000,
ID: 2821152 • Letter: O
Question
One year ago your company purchased a machine used in manufacturing for $90000, you can purchase it for $150,000 today. The CCA rate applicable to both machines is 30% and neither will have a long term salvage value. New machine will produce earnings before interest taxes depreciation and amortization of $35000 a year for the next 10 years. The current machine is expected to produce EBITDA of $21000 a year. Market value today of the current machine is 50000. The company’s tax rate is 40% and opportunity cost of capital 11%. Should the company replace the old machine and what is the NPV of the replacement. One year ago your company purchased a machine used in manufacturing for $90000, you can purchase it for $150,000 today. The CCA rate applicable to both machines is 30% and neither will have a long term salvage value. New machine will produce earnings before interest taxes depreciation and amortization of $35000 a year for the next 10 years. The current machine is expected to produce EBITDA of $21000 a year. Market value today of the current machine is 50000. The company’s tax rate is 40% and opportunity cost of capital 11%. Should the company replace the old machine and what is the NPV of the replacement. One year ago your company purchased a machine used in manufacturing for $90000, you can purchase it for $150,000 today. The CCA rate applicable to both machines is 30% and neither will have a long term salvage value. New machine will produce earnings before interest taxes depreciation and amortization of $35000 a year for the next 10 years. The current machine is expected to produce EBITDA of $21000 a year. Market value today of the current machine is 50000. The company’s tax rate is 40% and opportunity cost of capital 11%. Should the company replace the old machine and what is the NPV of the replacement.Explanation / Answer
This new machine SHOULD NOT be replaced, because NPV of replacement decision is negative.
NPV = - 20120.40
Step - 1 Compute the investment in Year = 0
Here we sell the old machine for 50000 and purchase the new machine for 150000. So additional funds needed = 150000 - 50000 = 100000. But old machine book value = 90000 - 30% = 63000. Selling this machine for 50000 = 63000 - 50000 = 13000 of loss.
Tax saved due this loss = 13000 * 0.40 = 5200
Net Investment at ,,,,,,,, t = 0 ,,,,,,,,,, = 150000 - 50000 - 5200 = 94800
Step - 2
Now calculate the annual cashflows for 1 to 10 years and NPV
In the above table, depreciation calculation is the main aspect. CCA rate is given as 30%. The difference in book values of old machine and new machine = 150000 - 63000 = 87000
Year - 1 = 87000 * 0.3 = 26100
Year - 2 = 26100 * 0.70 = 18270
Under CCA method, depreciation continues to decrease year by year at a rate of..... ( 1 - depreciation)
So depreciation of any year = previous depreciation * 0.70
1 2 3 4 5 6 7 8 9 10 Increase in Revenue 14000 14000 14000 14000 14000 14000 14000 14000 14000 14000 (-) Increase in Depreciation 26100 18270 12789 8952.3 6266.61 4386.627 3070.639 2149.447 1504.613 1053.229 Profit before tax -12100 -4270 1211 5047.7 7733.39 9613.373 10929.36 11850.55 12495.39 12946.77 (-) Tax -4840 -1708 484.4 2019.08 3093.356 3845.349 4371.744 4740.221 4998.155 5178.708 Profit after tax -7260 -2562 726.6 3028.62 4640.034 5768.024 6557.617 7110.332 7497.232 7768.063 (+) Depreciation 26100 18270 12789 8952.3 6266.61 4386.627 3070.639 2149.447 1504.613 1053.229 Cash flow after tax 18840 15708 13515.6 11980.92 10906.64 10154.65 9628.256 9259.779 9001.845 8821.292 Discounting factors 0.900901 0.811622 0.731191 0.658731 0.593451 0.534641 0.481658 0.433926 0.390925 0.352184 Present value of cash flows 16972.97 12748.97 9882.49 7892.203 6472.562 5429.091 4637.53 4018.063 3519.044 3106.722 Total of PV of cash flows 74679.64 Net Investment 94800 NPV -20120.4Related Questions
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