Question

Click here to read the book Replacement Analysis 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 $7,000 per year. The new machine will cost $40,000 delivered and installed, and its economice 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 purchase the new machine houd Save Continue

Answer 1

Given After Tax cashflow WACC Marginal Tax rate 7000 $ 10.00% 35% Solution Year GamlaON 0001- After Tax PVE PV cashflow -40000| 1 -40000.00 7000 0.909 6363.64 70001 0.826 5785.12 70001 0.751 5259.20 7000 0.683 4781.09 7000 0.621| 4346.45 7000 0.564 3951.32 70000.513 3592.11 70001 0.467 3265.55 7000 0.424 2968.68 70001 0.386 2698.80 NPV 3011.97 10 (1/(1+r)]^n where, PVF = where r is discount rate and n is Number of month PV = Saving X PVF As NPV of replacement is positive, Hence, oviedo should purchase the new machine *Note: It has been assumed that After tax cash flow is after adding back depreciation