Question

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 $150,000 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 $45,000 per year for the next ten years. The current machine is expected to produce EBITDA of $23,000 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 45%​, and the opportunity cost of capital for this type of equipment is 12%. Is it profitable to replace the​ year-old machine?

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

1 Cost of Capital 2 Purchase Price of New machine 3 market value of current machine 4 New Machine life (years) 12% 150,000.00 50,000.00 10 6 7 Initial cost Current Machine New Machine Incremental Cash Flows $ 100,000.00 $ 100,000.00 23,000.0045,000.00 8182.00 $ 15000.00 14,818.00 $30,000.00 6,668.10 13,500.00 16,500.00 10 EBIDTA 11 Deprecition 12 13 Tax 14 EAT 15 16 Cash Flow after Tax 17 18 Net Present Value (Incremental) 19 8,149.90 $16 16,331.90 31,500.00 15,168.10 ($14,296.85) As the Incremental NPV of New Machine is Negative, Thus,replacing Current Machine with New Machine is not Profitable Conclusion - 20 21

Cell reference -

1 Cost of Capital 2 Purchase Price of New machine 3 market value of current machine 4 New Machine life (years) 0.12 150000 50000 10 6 7 Initial cost 8 Current Machine New Machine Incremental Cash Flows 0 B2-B3 -C7-B7 10 EBIDTA 11 Deprecition 12 13 Tax 14 EAT 15 16 Cash Flow after Tax 17 18 Net Present Value (Incremental) 19 45000 23000 8182 -B10-B11 -B12*0.45 -B12-B13 B2/B4 C10-C11 C12*0.45 C12-C13 B14+B11 C14+C11 C16-B16 EPV(B1,B4,-D16,,0)-D7 As the Incremental NPV of New Machine is Negative, Thus,replacing Current Machine with New Machine is not Profitable Conclusion - 20 21

Incremental NPV of New machine is negative, Thus, replacing old machine is not profitable.

Hope this will help, please do comment if you need any further explanation. Your feedback would be appreciated.