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One year ago, your company purchased a machine used in manufacturing for $110,000. You have learned that a new machine is available that offers many advantages and you can purchase it for $150,000 today. It will be depreciated on a straight-line basis over 10 years and has no salvage value. You expect that the new machine will produce a gross margin (revenues minus operating expenses other than depreciation) of $40,000 per year for the next 10 years. The current machine is expected to produce a gross margin of $20,000 per year. The current machine is being depreciated on a straight-line basis over a useful life of 11 years, and has no salvage value, so depreciation expense for the current machine is $10,000 per year. The market value today of the current machine is $50,000. Your companys tax rate is 25%, and the opportunity cost of capital for this type of equipment is 10%. Should your company replace its year-old machine?

Old Machine $ 110,000 $ 10,000 $ 20,000 25% $ 2,500 $ 7,500 $ 10,000 $ 17,500 New Machine $ 150,000 $ 15,000 $ 40,000 $ 6,250 $ 18,750 $ 15,000 $ 33,750 Difference $ 16,250 0 0 1 2 3 3 4 5 6 6 7 8 9 10 3 4 Gross Margin 5 Depreciation 6 EBIT 7 Taxes 8 Net Income 9 Addback Depreciation 10 Operating Cash Flow 11 12 13 Cash Flow Table 14 Operating Cash Flow 15 New Asset Purchase 16 Sale of Old Asset 17 Total Cash Flow 18 NPV 19 20 21 Proceeds 22 BV 23 Loss on Sale 24 Tax Impact 25 26 Cash Impact 10% 27