Question

One year? ago, your company purchased a machine used in manufacturing for $95,000. You have learned that a new machine is available that offers many? advantages; you can purchase it for $160,000 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 $25,000 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 $8,636 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 38%?,and the opportunity cost of capital for this type of equipment is 11%.

What is the NPV of the replacement?

Is it profitable to replace the? year-old machine?

Answer 1

CALCULATION OF NPV OF REPLACEMENT

Depreciation of new machine =$160,000/10=$16,000

NPV of Replacement =NPV of incremental tax shield on depreciation+NPV of (incremental EBIT*net of tax) -Purchase Value of New Machine+Today's market Value of old current machine

=PVIFA(11%,10)*(Difference in Depreciation*tax rate)+PVIFA{(60,000-25000)*(100-38)%}- $160,000+$50,000

={5.889232*($16000-$8636)*38%}+5.889232*35000*62%- $160,000+$50,000

$16479.96+$127796.33-$160,000+$50,000 =$34,276.29

As NPV of replacement is positive,it is profitable to replace the current machine with new one.