X Company must decide whether to continue using its current equipment or replace
ID: 2575336 • 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: Current equipment Current sales value Final sales value Operating costs $10,000 2,000 61,500 New equipment Purchase cost Final sales value Operating cost savings $48,000 5,500 8,500 Maintenance work will be necessary on the new equipment in Year 4, costing $2,500. 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? 7102 Submit Answer Incorrect. Tries 2/5 Previous TriesExplanation / Answer
Net present value = PV of cash inflow - Initial cash outflow PV of cash inflow = $8500*PVIFA @6% 6 years+$5500*PVIF @6% 6 years - $2500*PVIF @6% 3 years (assume that the maintenance is at the beginning of year 4) = ($8500*4.9173)+($5500*0.705)-($2500*0.8396) = $41797.26+$3877.28-$2099 = $43575.5 Initial cash outflow = Purchase cost of new equipment - current sale value old equipment = $48000-$10000 = $38000 NPV = $43575.5 - $38000 = $5575.5 Since the NPV is positive it is suggested to buy the new machine If the maintenance is at the end of year 4. then; Net present value = PV of cash inflow - Initial cash outflow PV of cash inflow = $8500*PVIFA @6% 6 years+$5500*PVIF @6% 6 years - $2500*PVIF @6% 4 years (assume that the maintenance is at the end of year 4) = ($8500*4.9173)+($5500*0.705)-($2500*0.7921) = $41797.26+$3877.28-$1980.23 = $43694.31 Initial cash outflow = Purchase cost of new equipment - current sale value old equipment = $48000-$10000 = $38000 NPV = $43694.31 - $38000 = $5694.31 Since the NPV is positive it is suggested to buy the new machine
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