Question

Although the Chen Company's milling machine is old, it is still in relatively good working order and would last for another 10 years. It is inefficient compared to modern standards, though, and so the company is considering replacing it. The new milling machine, at a cost of $38,000 delivered and installed, would also last for 10 years and would produce after-tax cash flows (labor savings and depreciation tax savings) of $8,200 per year. It would have zero salvage value at the end of its life. The Project cost of capital is 12%, and its marginal tax rate is 35%. Should Chen buy the new machine?

Answer 1

Yes they should buy the new machine.

Step-by-step explanation:

since the new mill produces after tax cash savings of $8,200 per year, we should calculate the net present value of the 10 cash flows in order to determine if the project is profitable or not.

using a present value annuity factor for 10 years and 12% discount rate = 5.6502

the project's NPV = ($8,200 x 5.6502) - $38,000 = $46,331.64 - $38,000 = $8,331.64

since the NPV is positive, the project is profitable.