Question

One year​ ago, your company purchased a machine used in manufacturing for $105,000.

You have learned that a new machine is available that offers many advantages and that you can purchase it for $150,000 today. The CCA rate applicable to both machines is 20%​; neither machine will have any​ long-term salvage value. You expect that the new machine will produce earnings before​ interest, taxes,​ depreciation, and amortization​ (EBITDA) of $35,000 per year for the next 10 years. The current machine is expected to produce EBITDA of $24,000 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 40%​, and the opportunity cost of capital for this type of equipment is 10%. Should your company replace its​ year-old machine?

What is the NPV of​ replacement?

Answer 1

Price of machine 1 year ago = $105,000

Price of new machine now = $150,000

CCA Rate = 20%

New Machine EBITDA = $35,000 for 10 years

Current Machine EBITDA = $24,000

Sale of current Machine = $50,000

Tax Rate = 40%

Opportunity cost of equipment = 10%

NPV of replacement = $50,000-$150,000 + $35,000/(1.10) + $35,000/(1.10)^2 + $35,000/(1.10)^3 + $35,000/(1.10)^4 + $35,000/(1.10)^5 + $35,000/(1.10)^6 + $35,000/(1.10)^7 + $35,000/(1.10)^8 + $35,000/(1.10)^9 + $35,000/(1.10)^10

= $124,150

Since NPV is positive, company should replace its year old machine.