Dexter Smith & Co.is replacing a machine simply because it has worn out.The new machine will not affect either sales or operating costs and will not have any salvage value at the end of its 5-year life.The firm has a 34 percent tax rate,uses straight-line depreciation over an asset's life,and has a positive net income.Given this,which one of the following statements is correct?
A)As a project, the new machine has a net present value equal to minus one times the machine's purchase price.
B)The new machine will have a zero rate of return.
C)The new machine will generate positive operating cash flows, at least in the first few years of its life.
D)The new machine will create a cash outflow when the firm disposes of it at the end of its life.
E)The new machine creates erosion effects.

Question

Quizplus · Accepted Answer

Since the new machine will not affect sales or operating costs, it cannot have an impact on net income. However, it will generate positive operating cash flows as it will increase the efficiency of the production process leading to cost savings. Additionally, since it has no salvage value, it will not create a cash outflow at the end of its life. The machine's NPV will depend on its purchase price and the discount rate used, hence option A cannot be determined without additional information. The rate of return cannot be determined without knowing the cash flows generated by the machine, so option B is incorrect. Erosion effects are not relevant since the new machine does not affect sales.