This question is similar to question 2 but annual revenue is

This question is similar to question 2 but annual revenue is given and sale value is unknown:
Suppose you have to decide whether sell an old machine or keep it with a major overhaul. You can:

A) Sell the machine at time zero for X dollars with zero book value and paying the tax of 40%.

B) Keep the machine, which requires a major overhaul cost of $1,000,000 at time zero. The overhaul cost is depreciable from time 0 to year 5 (over six years) based on MACRS 5-year life depreciation with the half year convention (table A-1 at IRS (Links to an external site.)Links to an external site.). In this case machine can produce and generate equal annual revenue of 900,000 dollars for five years (year 1 to 5) and salvage value of the machine will be $250,000 with zero book value at the end of year 5. The operating cost of the machine will be $400,000 per year from year 1 to year 5.

Calculate the sale value, X, that can break-even the NPV of keeping the machine. Consider 40% income tax rate and after-tax minimum ROR of 16%.

Solution

Particulars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Annual Revenue $900000 $900000 $900000 $900000 $900000 Operating cost $400000 $400000 $400000 $400000 $400000 Less: Macrs Depreciation 20% of 1000000= 2000000 32% of 1000000= 320000 19.2% of 1000000= 192000 11.52% of 1000000= 115200 11.52% of 1000000= 115200 $57600 Salvage value $250000 Profits before tax ($200000) $180000 $308000 $384800 $384800 $692400 Less: Tax 40% $0 $72000 $123200 $153920 $153920 $276960 Incremental earning ($200000) $108000 $184800 $230880 $230880 $415440 Add: Depreciation $200000 $320000 $192000 $115200 $115200 $57600 Less: Initial Investment $1000000 Incremental free cashflow ($1000000) $428000 $376800 $346080 $346080 $473040 ROR 16% PV -1000000 $428000/1.16= $368965.52 $376800/(1.16)^2= $280023.78 $346080/(1.16)^3= $221718.81 $346080/(1.16)^4= $191136.90 $473040/(1.16)^5= $225220.50 NPV(Total of PV) $287065.51 Sales price of machine X= $287065.51/(1-40%)= $478442.52