One year ago, your company purchased a machine used in manufacturing for $120,00
ID: 2785090 • Letter: O
Question
One year ago, your company purchased a machine used in manufacturing for $120,000. You have learned that a new machine is available that offers many advantages; you can purchase it for $150,000 today. It will be depreciated on a straight-line basis over ten years, after which it has no salvage value. You expect that the new machine will contribute EBITDA (earnings before interest, taxes, depreciation, and amortization) of $60,000 per year for the next ten years. The current machine is expected to produce EBITDA of $20,000 per year. The current machine is being depreciated on a straight-line basis over a useful life of 11 years, after which it will have no salvage value, so depreciation expense for the current machine is $10,909 per year. All other expenses of the two machines are identical. The market value today of the current machine is $50,000. Your company's tax rate is 42%, and the opportunity cost of capital for this type of equipment is 11%. Is it profitable to replace the year-old machine? The NPV of the replacement is________(Round to the nearest dollar.)
Explanation / Answer
NPV = -75,181.82 + (24,918.18/0.11)*(1 – 1/1.11^10) = 71,567.14
As NPV is positive at required cost of capital, replacement is profitable.
Old Machine 0 1 2 3 4 5 6 7 8 9 10 Depreciation 10,909.09 10,909.09 10,909.09 10,909.09 10,909.09 10,909.09 10,909.09 10,909.09 10,909.09 10,909.09 Tax saving on depreciation 4,581.82 4,581.82 4,581.82 4,581.82 4,581.82 4,581.82 4,581.82 4,581.82 4,581.82 4,581.82 A Book Value -109,090.91 Market Value -50,000.00 After-tax MV = MV-(MV-BV)*Tax -74,818.18 B EBITDA 20,000.00 20,000.00 20,000.00 20,000.00 20,000.00 20,000.00 20,000.00 20,000.00 20,000.00 20,000.00 C Tax -8,400.00 -8,400.00 -8,400.00 -8,400.00 -8,400.00 -8,400.00 -8,400.00 -8,400.00 -8,400.00 -8,400.00 D Cash Flow (X) -74,818.18 16,181.82 16,181.82 16,181.82 16,181.82 16,181.82 16,181.82 16,181.82 16,181.82 16,181.82 16,181.82 sum A to D New Machine Initial cost -150,000.00 P Depreciation 15,000.00 15,000.00 15,000.00 15,000.00 15,000.00 15,000.00 15,000.00 15,000.00 15,000.00 15,000.00 Tax saving on depreciation 6,300.00 6,300.00 6,300.00 6,300.00 6,300.00 6,300.00 6,300.00 6,300.00 6,300.00 6,300.00 Q EBITDA 60,000.00 60,000.00 60,000.00 60,000.00 60,000.00 60,000.00 60,000.00 60,000.00 60,000.00 60,000.00 R Tax -25,200.00 -25,200.00 -25,200.00 -25,200.00 -25,200.00 -25,200.00 -25,200.00 -25,200.00 -25,200.00 -25,200.00 S Cash Flow (Y) -150,000.00 41,100.00 41,100.00 41,100.00 41,100.00 41,100.00 41,100.00 41,100.00 41,100.00 41,100.00 41,100.00 sum P to S Net Cash Flow (Y - X) -75,181.82 24,918.18 24,918.18 24,918.18 24,918.18 24,918.18 24,918.18 24,918.18 24,918.18 24,918.18 24,918.18 NPV @ 11% 71,567.14Related Questions
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