Break-Even Price Calculation: Example Question
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Firm AAA that is considering the purchase of a new machine. They have asked you to arrive to a break-even price, so that the NPV of the entire operation would be equal to zero. The new machine is expected to produce the following effects:
Operating expenses will be reduced by $12,000 per year for 10 years;
The existing machine is 5 years old and has 10 years of its scheduled life remaining. It was purchased for $45,000 and depreciated on a straight line basis over 15 years. Its salvage value was supposed to be zero at the end of its usage. It has a current market value of $35,000;
The new machine will be depreciated straight-line over its 10 years of life. Salvage value is expected to be $8,000.
The corporate tax rate is 35% and the cost of capital for the firm is 15%. Assume that all capital gains are taxable, while all capital losses are tax deductible.
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Solution provides stems necessary to calculate the break-even price.
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