X Company is considering replacing one of its machines in order to save operatin

Question

X Company is considering replacing one of its machines in order to save operating costs. Operating costs with the current machine are $64,000 per year; operating costs with the new machine are expected to be $35,385 per year. The new machine will cost $156,000 and will last for four years, at which time it can be sold for $1,000. The current machine will also last for four more years but will not be worth anything at that time. It cost $41,000 four years ago, but its current disposal value is only $6,000.

9. Assuming a discount rate of 7%, what is the incremental net present value of replacing the current machine?

10. Assume the following two changes: 1) both machines will last for six more years, 2) the salvage value of the new machine after six years will be zero. If X Company replaces the current equipment, what is the approximate internal rate of return?

Tries 0/3

Explanation / Answer

Solution 9:

Solution 10:

At IRR present value of incremental cash inflows will be equal to incremental cash outflows. Lets calculate NPV at 4% discount rate.

As Present value of incremental cash inflows are equal to incremental cash outflows. Therefore internal rate of return in 4%.

Computation of NPV - Replacement proposal of equipment - X Company Particulars Period Amount PV Factor at 7% Present Value Incremental Cash Outflows: Cost of new machine 0 $156,000.00 1 $156,000.00 Sale value of old machine 0 -$6,000.00 1 -$6,000.00 Present value of Incremental cash outflows (A) $150,000.00 Incremental Cash Inflows: Saving in annual operating cost 1-4 $28,615.00 3.38721 $96,925.05 Salvage value of new machine 4 $1,000.00 0.76290 $762.90 Present value of cash Inflows (B) $97,687.95 NPV (B-A) -$52,312.05

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