X Company must decide whether to continue using its current equipment or replace
ID: 2574838 • 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 4, costing $2,500. The current equipment will last for 5 more years; the life of the new equipment is also 5 years. Assuming a discount rate of 7%, what is the net present value of replacing the current equipment?
Current equipment Current sales value $10,000 Final sales value 3,500 Operating costs 65,000 New equipment Purchase cost $54,000 Final sales value 7,000 Operating costs 55,500Explanation / Answer
Year
Cash Flow
PV Factor Formula
PV Factor @ 7%
PV
0
($44,000)
1/(1+0.07)^0
1
($44,000.00)
1
$9,500
1/(1+0.07)^1
0.934579439
$8,878.50
2
$9,500
1/(1+0.07)^2
0.873438728
$8,297.67
3
$9,500
1/(1+0.07)^3
0.816297877
$7,754.83
4
$7,000
1/(1+0.07)^4
0.762895212
$5,340.27
5
$16,500
1/(1+0.07)^5
0.712986179
$11,764.27
NPV
($1,964.46)
Capital investment = Purchase cost of new machine – Current sales value of old machine
= $ 54,000 - $ 10,000 = $ 44,000
Year 1st through 3rd cash flow = Operating cost savings = $ 65,000 - $ 55,500 = $ 9,500
Year 4th cash flow = Operating cost savings – maintenance cost = $ 9,500 - $ 2,500 = $ 7,000
Year 5th cash flow = Operating cost savings + final sales value = $ 9,500 + $ 7,000 = $ 16,500
Year
Cash Flow
PV Factor Formula
PV Factor @ 7%
PV
0
($44,000)
1/(1+0.07)^0
1
($44,000.00)
1
$9,500
1/(1+0.07)^1
0.934579439
$8,878.50
2
$9,500
1/(1+0.07)^2
0.873438728
$8,297.67
3
$9,500
1/(1+0.07)^3
0.816297877
$7,754.83
4
$7,000
1/(1+0.07)^4
0.762895212
$5,340.27
5
$16,500
1/(1+0.07)^5
0.712986179
$11,764.27
NPV
($1,964.46)
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