Randi Corp. is considering the replacement of some machinery that has zero book
ID: 2591634 • Letter: R
Question
Randi Corp. is considering the replacement of some machinery that has zero book value and a current market value of $4,100. One possible alternative is to invest in new machinery that costs $31,300. The new equipment has a 5-year service life and an estimated salvage value of $4,800, will produce annual cash operating savings of $10,700, and will require a $3,500 overhaul in year 3. The company uses straight-line depreciation.
Required:
Prepare a net-present-value analysis of Randi’s replacement decision, assuming an 10% hurdle rate and no income taxes. Should the machinery be acquired? (Negative amounts should be indicated by a minus sign. Round calculations to the nearest dollar.)
Year FV of $1 at10% FV of an ordinary annuity at 10% PV of $1 at
10% PV of an ordinary annuity at 10% 1 1.100 1.000 0.909 0.909 2 1.210 2.100 0.826 1.736 3 1.331 3.310 0.751 2.487 4 1.464 4.641 0.683 3.170 5 1.611 6.105 0.621 3.791 6 1.772 7.716 0.564 4.355
Explanation / Answer
Cost of new machine = $31,300
Useful life = 5 Years
Salvage value = $4,800
Annual cash saving = $10,700
Overhaul in 3 Years = $3,500
Cost of capital = 10%
I am assuming that overhaul is in Starting of 3rd year or End of 2nd year
Initial investment = Cost of new machine – sale value of new machine + PV of Overhaul at the end of 2nd year
= $31,300 - $4,100 + (0.826*$3,500)
Initial investment = 30,091
PV of cash inflows = (Annual cash inflow*PVAF@10$ for 5 years) + (PVF@10% of 5th year*Salvage Value)
= ($10,700*3.791) + ($4,800*0.621)
PV of cash inflows = $43,544.5
NPV = PV of Cash Inflows – Initial investment
= $43,544.5 - $30,091
NPV = $13,453.5
Yes the machinery should be purchased as NPV is positive and investment will be financially viable.
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