The Chang Company is considering the purchase of a new machine to replace an obs

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 5 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 $10,500 per year. The new machine will cost $31,500 delivered and installed, and its economic life is estimated to be 5 years. It has zero salvage value. The firm’s WACC is 6.00%, and its marginal tax rate is 40%. Calculate the NPV of the replacement analysis?

Explanation / Answer

  PARTICULARS YEAR CASH FLOW PV FACTOR PRESENT VALUE

Machinery purchased 1 31500 1 (31500)

Cash Flows (BDAT) 1-5 10500 4.21 44205

Tax shield on dep. 1-5 2520 4.21 10609

   NPV 23314

Hence machinery should be replaced.

WORKINGS:-

DEPRECIATION = 31500 / 5

= $ 6300

TAX SHIELD ON DEPRECIATION = 6300 * 40%

= $ 2520

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