Should Big Power LLC Purchase the Machine?

Is it financially wise for Big Power LLC to purchase the machine?

Given the data provided, should Big Power LLC go ahead with the purchase?

Analysis of the Decision to Purchase the Machine

Big Power LLC is considering purchasing a machine with an expected useful life of 8 years for $80,000. The machine will generate $12,000 per year in EBITDA and will be depreciated linearly to its anticipated salvage value of $20,000. The firm has a 20% marginal tax rate and a required return of 12%. Let's analyze whether the machine should be purchased based on Net Present Value (NPV).

The decision whether to purchase the machine can be evaluated by calculating the Net Present Value (NPV) of the cash flows associated with the machine.

To calculate the NPV, we need to determine the annual cash flows generated by the machine and discount them to present value.

The annual cash flows consist of the earnings before interest, taxes, depreciation, and amortization (EBITDA) and the tax savings from depreciation.

Given that the machine generates $12,000 per year in EBITDA, we need to calculate the tax savings from depreciation.

The depreciation expense can be calculated by subtracting the salvage value from the initial cost of the machine and dividing it by the useful life of the machine. In this case, the depreciation expense is ($80,000 - $20,000) / 8 = $10,000 per year.

The tax savings from depreciation can be calculated by multiplying the depreciation expense by the marginal tax rate. In this case, the tax savings from depreciation is $10,000 * 0.20 = $2,000 per year.

Now, we can calculate the annual cash flow by summing the EBITDA and the tax savings from depreciation: $12,000 + $2,000 = $14,000 per year.

Next, we need to discount the annual cash flows to present value using the required return of 12%.

Calculating the present value of the cash flows for each year, and summing up the present values:

$12,500 + $11,160 + $9,955 + $8,868 + $7,885 + $7,001 + $6,204 + $5,485 = $69,048

The NPV can be calculated by subtracting the initial cost of the machine from the sum of the present values of the cash flows: NPV = $69,048 - $80,000 = -$10,952

Since the NPV is negative (-$10,952), it indicates that the present value of the cash flows is lower than the initial cost of the machine. Therefore, based on the NPV analysis, the machine should not be purchased.