Question
NVidia Ltd is considering replacing an old machine with a new one. The old one cost $100,000; the new one will cost $70,000. The new
NVidia Ltd is considering replacing an old machine with a new one. The old one cost $100,000; the new one will cost $70,000. The new machine will be depreciated prime cost to zero over its 5-year life. It will probably be worth about $15,000 after 5 years. The old machine is being depreciated at a rate of $5,000 per year. It will be completely written off in 5 years. If Nvidia does not replace it now, it will have to replace it in 5 years. Nvidia can sell it now for $55,000. In 5 years, it will probably be worth nothing. The new machine will save $10,000 per year in operating costs. The tax rate is 30%, tax is paid in the year of income.
NVidia Ltd has several classes of outstanding bonds, and the average yield is 8%. Its beta is 1.3, historical risk premium is 7.94%, and the treasury yield is 5%. If NVidias capital structure is 40% debt and 60% equity, should NVidia Ltd purchase the new machine? Explain your answer.
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