Question

ABC Corp. is considering replacing one of its existing machines with a new, more automated and efficient one. The old machine has a book value of $100,000. It could be sold today for $50,000. The remaining book value is being straight line depreciated to 0 salvage value, at the rate of $20,000/year. The new machine costs $400,000. If introduced, the company estimates that will save annually $60,000 on a before tax basis. This is considered a year end cash flow. The corporate tax rate is 40%; discount rate used is 15%. The new machine will be straight line depreciated on ten year life to 0 salvage value. In order to encourage the replacement of the old machine the state Environmental Protection Agency is offering a replacement subsidy. This is paid one year after the replacement. What is the minimum subsidy that will make the replacement worthwhile?

Answer 1

	Amount in $
Year	0	1	2	3	4	5	6	7	8	9	10	Total
Sale Value of Old Machine	50000
New Machine Cost	-400000
Cash Inflow		60000	60000	60000	60000	60000	60000	60000	60000	60000	60000
Depreciation on New Machine		-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000
Depreciation on Old Machine		-20000	-20000	-10000
Net Profit Before Tax		0	0	10000	20000	20000	20000	20000	20000	20000	20000
Tax		0	0	-4000	-8000	-8000	-8000	-8000	-8000	-8000	-8000
Net Profit After Tax		0	0	6000	12000	12000	12000	12000	12000	12000	12000
Add: Depreciation		60000	60000	50000	40000	40000	40000	40000	40000	40000	40000
Net Cash Inflow	-350000	60000	60000	56000	52000	52000	52000	52000	52000	52000	52000
Discounting Factor @15%	1	0.8696	0.7561	0.6575	0.5718	0.4972	0.4323	0.3759	0.3269	0.2843	0.2472
Present Value of Net Cash Inflow	-350000	52176	45366	36820	29734	25854	22480	19547	16999	14784	12854	-73387
Net Cash inflow for replacement	-73387
This would be received in the form of subsidy from Govt at end of Year 1 after replacement
Therefore the Present Value of minimum subsidy to be received from Govt ($)					84392
i.e. ($73387 / .8696)