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

For a problem like this (replacement) you value the incremental differences...i.e. the savings
CF0 = 168,000 - 10,000 proceeds on sale = CF0=(158,000)
CF1 thru 6:the savings: 66,050 - 35,540 = 30,510
IRR = 5%(approximately)

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