One year ago, your company purchased a machine used in manufacturing for $110 000. You have learned that a new machine is available that offers many advantages; you can purchase it for $150 000 today. It will be depreciated on a straight-line basis over 10 years and has no salvage value. You expect that the new machine will produce a gross margin (revenue minus operating expenses other than depreciation) of $40 000 per year for the next 10 years. The current machine is expected to produce a gross margin of $20 000 per year. The current machine is being depreciated on a straight-line basis over a useful life of 11 years, and has no salvage value, so depreciation expense for the current machine is $10 000 per year. The market value today of the current machine is $50 000. Your company’s tax rate is 30%, and the opportunity cost of capital for this type of equipment is 10%. Should your company replace its year-old machine?
When npv is worked out at the end, how would you determine if you should replace the machine or not?