Dave & Co. is replacing a machine because it has worn out. At the end of its 5 y

Question

Dave & Co. is replacing a machine because it has worn out. At the end of its 5 year life, the new machine will not affect either sales or operating costs and will not have a salvage value. The firm has a 34 percent tax rate, uses straight-line depreciation, and has a positive net income. Given this, which one of the following statements is correct?

As a project, the new machine has a net present value equal to minus one times the machine's purchase price.

The new machine will have a zero rate of return.

The new machine will generate positive operating cash flows, at least in the first few years of its life.

The new machine will create a cash outflow when the firm disposes of it at the end of its life.

The new machine creates erosion effects.

Explanation / Answer

The correct answer is "The new machine will generate positive operating cash flows, at least in the first few years of its life."

The reason being the benefit which comes from the depreciation tax shield offered on the new machine.

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