Although the Chen Company\'s milling machine is old, it is still in relatively g

Question

Although the Chen Company's milling machine is old, it is still in relatively good working order and would last for another 10 years. It is inefficient compared to modern standards, though, and so the company is considering replacing it. The new milling machine, at a cost of $39,000 delivered and installed, would also last for 10 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $8,600 per year. It would have zero salvage value at the end of its life. The firm's WACC is 9%, and its marginal tax rate is 35%.
Should Chen buy the new machine?

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Explanation / Answer

Answer

To Decide chen should buy new machine   ,we first need to calculate PV of an Annuity. If it's greater than the investment then buy it.

Get the PV of an Annuity of 8,600, N 10, R 9%

PVA = C [1-(1+r)-n / r]

PVA = 8600 [1-(1+9%)-10/9%]

PVA = $55,191.86

$55,191.86 (PVA) is greater than $39,000 (investment) .chen should buy new machine.

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