One year ago, your company purchased a machine used in manufacturing for $ 90,000 You have learned that a new machine is available that offers many advantages; you can purchase it for $140,000 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 $20,000 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 $8,182 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 42%, and the opportunity cost of capital for this type of equipment is 10%. Is it profitable to replace the year-old machine? The NPV of the replacement is $______ ?(Round to the nearest dollar.)
Additional Depreciation Benefit Depriciaition on New Machine =$140,000/10 =$14,000
Depriciation on Old Machine =$ 8182
Additional Depriciation on new Machine =$14,000 - $8,182 = $5,818
Cash Outflows Cost of New Machine Purchase =$140,000
Selling off the Existing Machine =$ -50,000
Net Cash Outflow =$ 90,000
Cash Inflows Increase in EBIDTA per year =$40,000 [$60,000 - $20,000]
Incremental Depriciation =$ 5,818 [$14,000 - $8,182]
Incremental Profit Before Tax =$ 34,182
Incremental Tax @ 42% =$ 14,356
Incremental Profit After Tax =$19,826 [$34,182 - $14,356] Add Depriciation =$ 5,818
Incremental Cash Flow =$ 25,644 [19,826 + 5,818 =25,644] This Cash inflow will be realized every year over the next 10 years, so calculating its Present Value, PVA(10%,10) = 25,644 x {(1-(1+0.10)-10)/0.10} = $121,822
NPV = PV of Cash Inflows - PV of Cash Outflows the capital loss on selling the original equipment.
If you paid $90K last year and it has one year of depreciation of $8181.82, then it's book value = Purchase Price less Accumulated Depreciation = $81,818.18
But, you sell it for $50,000 in cash. Capital Loss of $31,818.18 and you'll get a nice tax deduction, thus saving 13,363.64 on your tax bill.