Question

One year​ ago, your company purchased a machine used in manufacturing for $115,000. You have learned that a new machine is available that offers many​ advantages; you can purchase it for $140,000 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 $23,000 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 $10,455 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 45%​, and the opportunity cost of capital for this type of equipment is 11%. Is it profitable to replace the​ year-old machine?

Answer 1

Capital expenditure =140,000

Depreciation_new= 140000/10=14000

EBITDA _new = $60000

Depreciation_old= 115000/11=10455

EBITDA _old = $23000

MV_old=50000,

BV_old=? Cost –accumulated depreciation =115000-10455=104545

Made a capital loss of 54545 (BV>MV)

Tax saving on loss (=54545*0.45)

In Year 0, Cash inflow from sales of the old= 54545 + (54,545)*(0.45) = $70908  

FCFF = - 69092 + 21945.25 * PVF (11%, 10 yrs)

= -69092 + 21945.25 * 5.889

= 60148.67

NPV > 0 therefore replace the current machine with the new machine