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 $110,000 delivered and installed, would also last for 10 years and would produce after tax cash flows (labor savings and depreciation) of $19,000 per year. It would have zero salvage value at the end of its life. The project cost of capital is 10%, and its marginal tax rate is 35%. Should Chen buy the new machine?

Please show work, Thanks!

Answer 1

In this case we would calculate the net present value of new machine.
Net present value	Present value of cash inflow - Present value of cash outflow
If Net present value is positive then company should invest in the new machine.
Calculation of net present value is shown below
Year	0	1	2	3	4	5	6	7	8	9	10
After tax savings cash flow		$19,000	$19,000	$19,000	$19,000	$19,000	$19,000	$19,000	$19,000	$19,000	$19,000
Cost of new machine	-$110,000
Net cash flow	-$110,000	$19,000	$19,000	$19,000	$19,000	$19,000	$19,000	$19,000	$19,000	$19,000	$19,000
Discount factor @ 10%	$1.00000	$0.90909	$0.82645	$0.75131	$0.68301	$0.62092	$0.56447	$0.51316	$0.46651	$0.42410	$0.38554
Present value	-$110,000.00	$17,272.73	$15,702.48	$14,274.98	$12,977.26	$11,797.51	$10,725.00	$9,750.00	$8,863.64	$8,057.85	$7,325.32
Net present value	$6,746.775
Yes, The net present value of new machine is positive and thus Chen should purchase new machine.