X Company must decide whether to continue using its current equipment or replace
ID: 2575117 • 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 $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 8%, what is the net present value of replacing the current equipment?
Current equipment Current sales value $5,000 Final sales value 3,500 Operating costs 65,000 New equipment Purchase cost $47,000 Final sales value 7,000 Operating cost savings 8,500Explanation / Answer
Calculation of present value of cash out flows:
Particulars
Amount
Purchase price of new machine
$47,000
Less: current sale value of current machine
$5,000
p.v of cash outflow in Year 1
$42,000
P.V of Cash out flow in year 3 = $2,500*p.v factor @ 8% at 3rd year
P.V of Cash out flow in year 3 = $2,500*0.7938
$1,985
Total Cash outflows (42,000+1,985)
$43,985
Calculation of present value of cash inflows:
Annual operating savings
$8,500
Annuity factor @ 8% for 5 years
3.9927
P.V of cash inflows from savings (9,000*4.7665)
$33,938
P.v of inflows from final sale value = $7,000*P.v factor @ 8% st 5th year
P.v of inflows from final sale value = $7,000*0.6805
$4,764
Total Cash Inflows (33,938+4,764)
$38,702.12
Ans
Net present value = P.V of cashinlows - p.v of cash outflows
NPV = 38,702.12-43,985
($5,282.46)
Calculation of present value of cash out flows:
Particulars
Amount
Purchase price of new machine
$47,000
Less: current sale value of current machine
$5,000
p.v of cash outflow in Year 1
$42,000
P.V of Cash out flow in year 3 = $2,500*p.v factor @ 8% at 3rd year
P.V of Cash out flow in year 3 = $2,500*0.7938
$1,985
Total Cash outflows (42,000+1,985)
$43,985
Calculation of present value of cash inflows:
Annual operating savings
$8,500
Annuity factor @ 8% for 5 years
3.9927
P.V of cash inflows from savings (9,000*4.7665)
$33,938
P.v of inflows from final sale value = $7,000*P.v factor @ 8% st 5th year
P.v of inflows from final sale value = $7,000*0.6805
$4,764
Total Cash Inflows (33,938+4,764)
$38,702.12
Ans
Net present value = P.V of cashinlows - p.v of cash outflows
NPV = 38,702.12-43,985
($5,282.46)
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