5. Equipment replacement decision Columbia Enterprises is studying the replaceme

Question

5. Equipment replacement decision
Columbia 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 $8,700 of major repairs are performed in two years. Annual cash operating costs total $27,200. Columbia can sell the equipment now for $36,000; 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 $103,000, 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. Columbia 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 Columbia should keep its present equipment or acquire the new equipment. Round all calculations to the nearest dollar, and ignore income taxes.
b.   Columbia's management feels that the time value of money should be considered in all long-term decisions. Briefly discuss the rationale that underlies management's belief.

Explanation / Answer

Answer :

Since NPV is -30521.90 so old machine  should not be replace.

Answer (b) : . Long term investment or capital expenditure are long term decision and involved high investment. Therefore it is necessary to consider the time value of money.Firm have limited capital investment. they should invest the money where the get the better return. So, before the investment in long term projects time value of money should be considered.

Particulars Amount ($) If we replace old machine to new Machine Saving in Annual cost p.a. (27200-21000) 6200.00 PVIFA factor @ 12%, 6years 4.11 Present value of total saving 25488.20 Repairing cost saving 8700.00 PVIF factor @ 12%, 2years 0.80 Present value of repairing expenses 6933.90 6933.90 Residual value of new machine after six years 13000.00 PV factor @ 12%, 6th year 0.51 Present value of residual vale of new machine 6591.00 6591.00 Total Present Value for new machine 39013.10 Less residual value of old machine 5000.00 PV factor @ 12%, 6th year 0.51 Present value of residual vale of new machine 2535.00 2535.00 Present Value saving on replacement 36478.10 Add Sales value of old machine 36000.00 Present value of cash saving 72478.10 Less Equipment cost 103000.00 Net Present Value of Replacement -30521.90

Related Questions

Navigate

• Browse (All)
• Browse 5
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.