The Oviedo Company is considering the purchase of a new machine to replace an obsolete one. The machine being used for the operation has a book value and a market value of zero. However, the machine is in good working order and will last at least another 10 years. The proposed replacement machine will perform the operation so much more efficiently that Oviedo’s engineers estimate that it will produce after-tax cash flows (labor savings) of $8,000 per year. The after-tax cost of the new machine is $45,000, and its economic life is estimated to be 10 years. It has zero salvage value. The firm’s WACC is 10%, and its marginal tax rate is 25%. Should Oviedo buy the new machine?

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TomShelby TomShelby · Answer 1 · 2019-11-15T04:15:19+01:00

Answer:

Yes it should as the net present value at the firm WACC is positive $ 4,156.54

Explanation:

we are given with the after-tax cost for the machine and after-tax cost of the labor cost savings the new machine will provide

So we should check if the present value of the savings is greater or equal than the machine cost:

[tex]C \times \frac{1-(1+r)^{-time} }{rate} = PV\\[/tex]

C $ 8,000

time 10 years

rate=WACC= 0.1

[tex]8000 \times \frac{1-(1+0.1)^{-10} }{0.1} = PV\\[/tex]

PV $49,156.5368

Net present value:

inflow - cost

49,156.54 - 45,000 = 4,156.54