X Company must decide whether to continue using its current equipment or replace
ID: 2573901 • 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:
Maintenance work will be necessary on the new equipment in Year 3, costing $4,000. The current equipment will last for 6 more years; the life of the new equipment is also 6 years. Assuming a discount rate of 6%, what is the net present value of replacing the current equipment?
Current equipment Current sales value $10,000 Final sales value 2,000 Operating costs 66,500 New equipment Purchase cost $50,000 Final sales value 6,500 Operating cost savings 10,000Explanation / Answer
initial investment of new equipment = cost of purchase - sales value of old equipmenmt
= 50000 - 10000
=$ 40000
operating cost savings = $ 10000 (given)
NPV Of replacing current equipment = present value of savings in operating cost -present value of maintenance cost - present value of cash outflow + present value of salvage
= 10000 * PVAF (6% , 6 years ) - 4000* PVF (6%, 3rd year) - 40000 +6500 * PVF (6% , 6th year)
=49173 - 3358 - 40000 + 4582
= $10397
as NPV of replacing current equipmemt is positive , therefore company should replace the equipment.
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