Question

PLEASE SHOW (STEP-BY-STEP) HOW YOU WOULD SOLVE TO FIND THE ANSWER.

REPLACEMENT ANALYSIS The Oviedo Company is considering the purchase of a new machine to replace an obsolete one. The machine being used for the operation has a book value and a market value of zero. However, the machine is in good working order and will last at least another 10 years. The proposed replacement machine will perform the operation so much more efficiently that Oviedo's engineers estimate that it will produce after-tax cash flows (labor savings and depreciation) of $6,000 per year. The new machine will cost $40,000 delivered and installed, and its economic life is estimated to be 10 years. It has zero salvage value. The firm's WACC is 10%, and its marginal tax rate is 35%. Should Oviedo buy the new machine? Oviedo should purchase the new machine.

Answer 1

Time line		0	1	2	3	4	5	6	7	8	9	10
Cost of new machine		-40000
=Initial Investment outlay		-40000
													100.00%
Savings			6000	6000	6000	6000	6000	6000	6000	6000	6000	6000
-Depreciation	Cost of equipment/no. of years		-4000	-4000	-4000	-4000	-4000	-4000	-4000	-4000	-4000	-4000	0	=Salvage Value
=Pretax cash flows			2000	2000	2000	2000	2000	2000	2000	2000	2000	2000
-taxes	=(Pretax cash flows)*(1-tax)		1300	1300	1300	1300	1300	1300	1300	1300	1300	1300
+Depreciation			4000	4000	4000	4000	4000	4000	4000	4000	4000	4000
=after tax operating cash flow			5300	5300	5300	5300	5300	5300	5300	5300	5300	5300
+Tax shield on salvage book value	=Salvage value * tax rate											0
=Terminal year after tax cash flows												0
Total Cash flow for the period		-40000	5300	5300	5300	5300	5300	5300	5300	5300	5300	5300
Discount factor=	(1+discount rate)^corresponding period	1	1.1	1.21	1.331	1.4641	1.61051	1.771561	1.9487171	2.1435888	2.357948	2.593742
Discounted CF=	Cashflow/discount factor	-40000	4818.181818	4380.165289	3981.968445	3619.9713	3290.883	2991.7118	2719.738027	2472.4891	2247.717	2043.379
NPV=	Sum of discounted CF=	-7433.79

Donot purchase as NPV is negative