Help mw ith tis One year ago, your company purchased a machine used in manufactu
ID: 2701910 • Letter: H
Question
Help mw ith tis
One year ago, your company purchased a machine used in manufacturing for $ 110,000. You have learned that a new machine is available that offers many advantages, you can purchase h for $160,000 today. It will be depredated on a straight-line basis over ten 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 $45,000 per year for the next ten years. The current machine is expected to produce a gross margin of $24,000 per year. The current machine is being depredated on a straight-line basis over a useful life of 11 years, and has no salvage value, so depredation expense for the current machine is $10,000 per year. The market value today of the current machine is $45,000. Your company's tax rate is 42%, and the opportunity cost of capital for this type of equipment is 10%. Should your company replace its year-old machine?Explanation / Answer
Hi,
Please find the answer as follows;
Incremental revenues: 0
Incremental costs: -160000
Depreciation: 10000 per year
Capital Gain on Salvage: 45000
Cash Flow from Salvage Value: 45000 - (45000)(0.42) = 26100
Replacing the Machine will increae EBITDA = 45000 - 24000 = 21000
Increase in Depreciation Expense = 16000 - 10000 = 6000
Free Cash Flow = 21000*(1-.42) + 6000*.42 = 14700 (Year 1 to Year 10)
Year 0 Free Cash Flow = -160000 + 45000 + 55000*.42 = -91900
NPV of Replacement = -91900+ 14700/(1+.10)^1 + 14700/(1+.10)^2 + 14700/(1+.10)^3 + 14700/(1+.10)^4 + 14700/(1+.10)^5+ 14700/(1+.10)^6 + 14700/(1+.10)^7 + 14700/(1+.10)^8 + 14700/(1+.10)^9 + 14700/(1+.10)^10 = -1574.86
No, the machine should not be replaced.
Thanks.
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