Richardson Enterprises is studying the replacement of some equipment that origin

Question

Richardson Enterprises is studying the replacement of some equipment that originally cost $74,000. The equipment is expected to provide six more years of service if $8,500 of major repairs are performed in two years. Annual cash operating costs total $28,000. Richardson can sell the equipment now for $37,000; the estimated residual value in six years is $5,000.

New equipment is available that will reduce annual cash operating costs to $21,000. The equipment costs $105,000, has a service life of six years, and has an estimated residual value of $13,000. Company sales will total $430,000 per year with either the existing or the new equipment. Richardson has a minimum desired return of 12% and depreciates all equipment by the straight-line method.

Instructions:

a.     By using the net-present-value method, determine whether Richardson should keep its present equipment or acquire the new equipment. Round all calculations to the nearest dollar, and ignore income taxes.

b.     Richardson

Explanation / Answer

If the company keeps the machine, the cost incurred each year will be as follows


year 0 0 = $0.00

year 1 = 21000 = $21,000.00

year 2 = 21000 + 8500 = $29500.00

year 3 = 21000 = $ 21000.00

year 4 = 21000 = $ 21000.00

year 5 = 21000 = $ 21000.00

year 6 = 21000 - 5000 = $26000.00

NPV of all costs @ 12% = $116,232.71

If the company replaces the machine, the cost incurred each year will be as follows

year 0 = $103000 - $36000 = $67,000.00

year 1 =21000 = $21,000.00

year 2 =21000 = $21,000.00

year 3 =21000 = $21,000.00

year 4 =21000 = $21,000.00

year 5 =21000 = $21,000.00

year 6 =21000 - 13,000 = $8,000.00

NPV of all costs @ 12% = $146,753.35

So replacing is more expensive option. therefore it should keep the original machines

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