Q1. Two years ago, Med Pharmaceutical purchased a machine used in manufacturing capsules for $105,000. The production manager, Doug, has learned that a new machine is available that will produce capsules around 60% faster than the existing machine. This new machine can be purchased for $100,000 today and would be fully depreciated on a straight-line basis over a useful life of 5 years, after which it has no salvage value. Doug expects that the new machine will produce an operating income (which is equal to revenue minus COGS and overhead costs) of $45,000 per year for the next five years (year 1 to 5) while the existing machine produces an operating income of only $30,000 per year. The current machine is being fully depreciated on a straight-line basis over a useful life of 7 years, after which it will have no salvage value. All other operating expenses are identical for both machines. The existing machine can be sold for $60,000 today if the company elect to upgrade to the new machine. Med Pharmaceuticals tax rate is 30%, and the opportunity cost for this type of equipment is 10%. Assume all cash flows are incurred at the end of each year. Is it profitable to replace the old machine by the new one?

Use the template below to work out the future incremental FCFs from replacing the old machine and calculate the NPV of replacement. Please make sure you clearly label any extra lines you add (to show your workings). You do not have to fill in all cells. Show your detailed workings in the space provided on the next page.

Year 2 AEBIT (new - old) AEBIAT (new - old) AD&A (new - old) Incremental CFO Incremental Capex Incremental Increases in OWC Cash flow from asset sale Incremental FCF DF PV NPV