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 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)

Current equipment    Current sales value $18,000    Final sales value 3,690    Operating costs 66,050 New equipment    Purchase cost $168,000    Final sales value 3,690    Operating costs 35,540

Explanation / Answer

Note: cash flow in 6th year = $30510 + $3690 = $34200

By interpolation we get,

R = 10% +(5%-10%)*((0+15078)/(7623+15078)) = 0.067

IRR = 0.067

Purchase price $   1,68,000.00 sale value of the current equipment $       18,000.00 Net cash out flow to purchase new machine $   1,50,000.00 operating cost of the old machine $       66,050.00 less: operating cost of the new machine $       35,540.00 Cash flow from savings in operating cost $       30,510.00

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