Question

# One year? ago, your company purchased a machine used in manufacturing for \$95,000. You have learned...

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?

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.

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