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 $42,000 delivered and installed, would also last for 10 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $8,300 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

Answer : Chen should buy new machine.

Explanation :

Calculation of NPV of the project

NPV = Present value of cash inflow - Present Value of cash outflow

Given Cash outflow is $ 42,000

After Tax Cash flows from year 1-10 is $ 8300 per year

Below is the table showing discounted value of Cash flow :

Year	Cash Inflows	Present value annuity factor @ 11 % for 10 years	Discounted Cash flows
1-10	$ 8,300	5.88923201096	48880.6256909

Present Value of Cash Inflow	48,880.6256909
(-)Present Value of cash outflow	(42,000)
Net Present Value	6,880.6256909

Since NPV($ 6,880.6256909) of the Machine is positive, Chen should buy new machine.

Note :

Present Value Annuity Factor can be calculated by using following formula :

Annuity Factor = {1 - [ 1 / (1+r)n] } / r

where r = Interest rate i.e 11 %

n = number of years i.e 10 years