Question

ABC company is considering replacing their old manual loading machine with an automatic loading machine. The...

ABC company is considering replacing their old manual loading machine with an automatic loading machine. The manual machine cost $300000 three years ago, and is being depreciated over 10 years straight line depreciation, with no salvage value. If ABC replaces the manual machine, the new automatic machine will cost $4000000 and have a useful life of 10 years. This will also be depreciated on a straight line basis to zero. As a result of this new machine, there will be pretax savings of $130000 in labour costs and $25000 in other cash expenses annually. If the automatic machine is purchased, the old machine will immediately be sold at a price of $280000. The company has already spent $11500 researching costs associated with this decision. The company's tax rate is 40% and no inflation is expected. The company's cost of capital is 7%.

Required: Calculate the Net Present Value of this decision and state with supportive reason, whether or not your company should purchase the automatic machine.

Homework Answers

Answer #1

Net Present value = Present value of cash inflow - present value of cash outflows

The researching costs already incurred are sunk costs and are not relevant for this decision

Written down value of old machine = 300,000*7/10 = 210,000

Selling Price = $280,000

Gain on Sale = $70,000

Tax = 70,000*40% = 28,000

Selling price after tax = 280,000-28,000 = $252,000

Annual Depreciation on new machine = 4,000,000/10 = $400,000

NPV = -4,000,000+252,000 + [(130,000+25,000- 400,000)(1-40%)+400,000]*PVAF(7%, 10 years)

= -3,748,000 + 253,000*7.02358

= -$1,971,033.87

Since, NPV is negative, the new machinery should not be purchased

Note: Please cross check the number of zeros in the purchase price of new machine. The solution is correct for the posted figure of $4,000,000

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