Should you replace the old machine with the new machine

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Reference no: EM133633094

Quesiton: Your firm is considering replacing an old machine with a new machine. The new machine will cost $5 ?million and will produce free cash flows of $4.5 ?million per year for the next five years. The new machine will be depreciated on a straight-line basis to a book value of 0?and will have a salvage value of $1.25 ?million after five years.

The existing machine currently has a book value of $1 ?million and can be sold today for $2 ?million. If left in place (i.e. ?if you not replace it), ?it will produce free cash flows of $2 ?million per year for five years. After five years it will have a book value of 0 ?and a salvage value of $0.5 ?million.

Should you replace the old machine with the new machine? The WACC for both machines is 10% ?and the firm's tax rate is 40%.

Hint: Focus on incremental cash flows (i.e. ?how cash flows change if you replace the machine).

Reference no: EM133633094

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