X Company must decide whether to continue using its current equipment or replace
ID: 2463592 • 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:
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) Have to use present value of an annuity of $1.00 table
Current equipment Current sales value $20,000 Final sales value 3,520 Operating costs 69,210 New equipment Purchase cost $170,000 Final sales value 3,520 Operating cost savings 32,450Explanation / Answer
In order to compute the IRR, the discount factor will have to be computed first by dividing the investment required to be made in the new equipment by the annual operating cost savings .
Cost of new equipment = $170,000
Current sales value of current equipment = $20,000
Therefore,
Investment required to be made = $170,000 - $20,000 = $150,000
And,
Annual operating cost savings = $32,450
Thus,
Discount factor = $150,000 / $32,450 = 4.62
In the present value annuity table, a discount factor of 4.62 for 6 periods shows interest rate of 8%.
Hence the IRR is 8%.
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