Interstate Manufacturing is considering either replacing one of its old machines

Question

Interstate Manufacturing is considering either replacing one of its old machines with a new machine or having the old machine overhauled. Information about the two alternatives follows. Management requires a 12% rate of return on its investments. Use the (PV of $1. FV of $1. PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.) Alternative 1: Keep the old machine and have it overhauled. If the old machine is overhauled, it will be kept for another five years and then sold for its salvage value Cost of old machine Cost of overhaul Annual expected revenues generated Annual cash operating costs after overhaul Salvage value of old machine in 5 years $113,000 154,000 104,000 43,000 17,000 Alternative 2: Sell the old machine and buy a new one. The new machine is more efficient and will yield substantial operating cost savings with more product being produced and sold Cost of new machine Salvage value of old machine now Annual expected revenues generated Annual cash operating costs Salvage value of new machine in 5 years $298,000 30,000 85,000 27,000 11,000 Required

Explanation / Answer

Net Present value of Alternative -1 Initial Cash Investment 154,000 (cost of overhaul) Chart values are based on : I = 12% YEAR Cash Inflow/Outflow   * Table Factor = Present value 1 61000 0.893 54473 2 61000 0.797 48617 3 61000 0.712 43432 4 61000 0.636 38796 5 78000 0.568 44304 (Including Salvage value) Totals 229622 Present value of cash inflows and salvage value 229622 Less: Present value of cash outflow of cost of overhauling 154000 Net Present value 75622 Net Present value of Alternative -2 Initial Cash Investment 268,000 (cost of machine-salvage valueof old machine) Chart values are based on : I = 12% YEAR Cash Inflow/Outflow   * Table Factor = Present value 1 58000 0.893 51794 2 58000 0.797 46226 3 58000 0.712 41296 4 58000 0.636 36888 5 69000 0.568 39192 (Including Salvage value) Totals 215396 Present value of cash inflows and salvage value 215396 Less: Present value of cash outflow of cost of overhauling 268000 Net Present value -52604 Mgt should select Alternative -1

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