The Chang Company is considering the purchase of a new machine to replace an obs
ID: 2713026 • Letter: T
Question
The Chang Company is considering the purchase of a new 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 Chang's engineers estimate that it will produce after- tax cash flows (labor savings and depreciation) of $9,000 per year. The new machine will cost $40,000 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 Chang buy the new machine? (Answers found so far haven't addressed the tax rate part of the question.)
Explanation / Answer
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Initial cost (40,000) After tax cash low 9,000 9,000 9,000 9,000 9,000 9,000 9,000 9,000 9,000 9,000 Total Cash Flow (40,000) 9,000 9,000 9,000 9,000 9,000 9,000 9,000 9,000 9,000 9,000 Discount rate@10% 1.000 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 PV of cash flows (40,000) 8,182 7,438 6,762 6,147 5,588 5,080 4,618 4,199 3,817 3,470 NPV 15,301 Assumed that the after tax cash flow includes cash flow from adding back the depreciation to post tax income. As the NPV of the savings from new machine is positive, Chang should buy the machine.
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