Your business is evaluating the replacement of one of its machines
Your business is evaluating the replacement of one of its machines. The machine was originally purchased ten
years ago at a cost of $35,000 and has been depreciated to a book value of zero. If your company replaces the machine, it will be able to bid on larger projects that require the capabilities of the new machine. The new machine will cost the firm $80,000, which will be depreciated over 4 years according to the following depreciation rates: 40% in each of years 1 and 2, and 10% in each of years 3 and 4. The new machine qualifies for an immediate 2% investment tax credit. Your company anticipates that at the end of the machine’s eight year economic life it will be sold for $10,000. Your company estimates that its existing machine can be sold today for $5,000. If your business does not replace the machine, it anticipates being able to use the existing machine for eight more years at which time its salvage value would be zero. Without the purchase of the new machine, you expect to generate revenue of $200,000 per year.
The firm’s use of its existing machine is expected to generate operating expenses of $120,000 per year. If the new machine is purchased, the company expects the firm’s annual revenues and operating costs to increase to $270,000 and $170,000 respectively. The company’s marginal tax rate is 40%. To finance this project, the business will raise 30% of the capital from debt and 70% of the capital from equity; its after-tax cost of debt is 8% and the cost of equity is 18%.
(18) a. Calculate the NPV for this project.