X Company must decide whether to continue using its current equipment or replace
ID: 2463320 • Letter: X
Question
X Company must decide whether to continue using its current equipment or replace it with new, more efficient equipment. The following information is available for the current and new equipment:
Current equipment
Current sales value
$10,000
Final sales value
2,970
Operating costs
65,060
New equipment
Purchase cost
$160,000
Final sales value
2,970
Operating costs
35,510
The current and new equipment will last for 6 years. If X Company replaces the current equipment, what is the approximate internal rate of return (enter your rate as a decimal; so 1% would be .01)
Current equipment
Current sales value
$10,000
Final sales value
2,970
Operating costs
65,060
New equipment
Purchase cost
$160,000
Final sales value
2,970
Operating costs
35,510
Explanation / Answer
CALCULATION OF IRR:
NET INITIAL CASH OUTFLOW ON NEW EQUIPMENT = PURCHASE COST OF NEW EQUIPMENT - CURRENT SALE VALUE OF CURRENT EQUIPMENT = $160,000 - 10,000 = $150,000
NET SAVINGS IN OPERATING COST OF NEW EQUIPMENT = OPERATING COST OF CURRENT EQUIPMENT - OPERATING COST OF NEW EQUIPMENT = $65060 - 35,510 = $29,550
ANNUITY FACTOR = NET INITIAL CASH OUTFLOW/SAVINGS IN OPERATING COST
= $150,000/29,550 = 5.076
IF WE LOOK AT PRESENT VALUE FACTOR OF AN ANNUITY TABLE, WE CAN FIND THIS ANNUITY FACTOR FOR 6 YEARS @ 5%, SO IRR OF THE COMAPANY IF IT REPLACE THE CURRENT EQUIPMENT WITH NEW EQUIPMENT IS 5%. THIS CAN BE EXPRESSED IN DECIMAL AS 0.05
NOTE: * No effect of Final salvage value as both equipment have same Finla sale value
* Depreciation on new equipment has also no effect as there is no corporate tax
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