X Company must decide whether to continue using its current equipment or replace

Question

X Company must decide whether to continue using its current equipment or replace it with new, more efficient equipment. The current equipment will last for six more years and has a current disposal value of $14,000. The new equipment will cost $164,000 and will also last for six years. Operating costs with the current equipment are $66,500 and operating costs with the new equipment are $34,050. If X Company replaces the current equipment, what is the approximate internal rate of return?

I did: 164,000-14,000=150,000/(66,500-34,050)=4.622, so I said the IRR is 8%. It's not correct, what did I do wrong?

Explanation / Answer

Hi,

Please find the answer as follows:

Initial Cash Outflow = 164000 - 14000 = 150000

Annual Cash Savings = 66500 - 34050 = 32450

For calculating IRR, you need to put the value of NPV as 0.

NPV = 0 = -150000 + 32450/(1+R)^1 + 32450/(1+R)^2 + 32450/(1+R)^3 + 32450/(1+R)^4 + 32450/(1+R)^5 + 32450/(1+R)^6

Solving for R, we get IRR as 8%

Answer is 8%.

Thanks.

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