One year? ago, your company purchased a machine used in manufacturing for $105,000. You have learned...

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One year? ago, your company purchased a machine used inmanufacturing for $105,000. You have learned that a new machine isavailable that offers many advantages and you can purchase it for$140,000 today. It will be depreciated on a? straight-line basisover 10 years and has no salvage value. You expect that the newmachine will produce a gross margin? (revenues minus operatingexpenses other than? depreciation) of $35,000 per year for the next10 years. The current machine is expected to produce a gross marginof $20,000 per year. The current machine is being depreciated on a?straight-line basis over a useful life of 11? years, and has nosalvage? value, so depreciation expense for the current machine is$9,545 per year. The market value today of the current machine is$65,000. Your? company's tax rate is 45%?, and the opportunity costof capital for this type of equipment is 11%. Should your companyreplace its? year-old machine?

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3.6 Ratings (358 Votes)

Time line		0	1	2	3	4	5	6	7	8	9	10
Proceeds from sale of existing asset	=selling price* ( 1 -tax rate)	35750
Tax shield on existing asset book value	=Book value * tax rate = (105000-9545)*0.45	42954.75

Cost of new machine		-140000

=Initial Investment outlay		-61295.25



Incremental Profits	=35000-20000		15000	15000	15000	15000	15000	15000	15000	15000	15000	15000


-Depreciation	Cost of equipment/no. of years		-14000	-14000	-14000	-14000	-14000	-14000	-14000	-14000	-14000	-14000

=Pretax cash flows			1000	1000	1000	1000	1000	1000	1000	1000	1000	1000
-taxes	=(Pretax cash flows)*(1-tax)		550	550	550	550	550	550	550	550	550	550
+Depreciation			14000	14000	14000	14000	14000	14000	14000	14000	14000	14000
=after tax operating cash flow			14550	14550	14550	14550	14550	14550	14550	14550	14550	14550




+Tax shield on salvage book value	=Salvage value * tax rate											0
=Terminal year after tax cash flows												0

Total Cash flow for the period		-61295.25	14550	14550	14550	14550	14550	14550	14550	14550	14550	14550
Discount factor=	(1+discount rate)^corresponding period	1	1.11	1.2321	1.367631	1.5180704	1.6850582	1.8704146	2.07616	2.30454	2.558037	2.839421
Discounted CF=	Cashflow/discount factor	-61295.25	13108.108	11809.1064	10638.835	9584.5357	8634.7168	7779.0242	7008.13	6313.63	5687.955	5124.284
NPV=	Sum of discounted CF=	24393.07576

Replace project as NPV is positive

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Transcribed Image Text

One year? ago, your company purchased a machine used inmanufacturing for $105,000. You have learned that a new machine isavailable that offers many advantages and you can purchase it for$140,000 today. It will be depreciated on a? straight-line basisover 10 years and has no salvage value. You expect that the newmachine will produce a gross margin? (revenues minus operatingexpenses other than? depreciation) of $35,000 per year for the next10 years. The current machine is expected to produce a gross marginof $20,000 per year. The current machine is being depreciated on a?straight-line basis over a useful life of 11? years, and has nosalvage? value, so depreciation expense for the current machine is$9,545 per year. The market value today of the current machine is$65,000. Your? company's tax rate is 45%?, and the opportunity costof capital for this type of equipment is 11%. Should your companyreplace its? year-old machine?