Question

Although the Chen Company's milling machine is old, it is still in relatively good working order and would last for another 10 years. It is inefficient compared to modern standards, though, and so the company is considering replacing it. The new milling machine, at a cost of $40,000 delivered and installed, would also last for 10 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $9,000 per year. It would have zero salvage value at the end of its life. The Project cost of capital is 11%, and its marginal tax rate is 35%.
Should Chen buy the new machine?

Answer 1

Net Present Value (NPV) Analysis

Net Present Value = Present Value of annual cash inflows – Initial Investment

= $9,000[PVIFA 11%, 10 Years] - $40,000

= [$9,000 x 5.88923] - $40,000

= $53,003.09 - $40,000

= $13,003.09 (Positive NPV)

DECISION

YES, The Chen Company should buy the new machine since the Net Present Value (NPV) from the new machine is Positive $13,003.09 and therefore, the New Machine should be purchased.

NOTE

The Present Value Annuity Inflow Factor (PVIFA 11%, 10 Years) is the value taken from the Present Value Annuity Factor table corresponding to the Interest Rate of 11% and the period of 10 Years.