X Company must decide whether to continue using its current equipment or replace

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 $5,000 3,500 69,500 New equipment Purchase cost Final sales value Operating costs $50,000 5,500 60,500 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?

Explanation / Answer

To calculate the present value we have to calculate the present value of cashflows as et Present value = PV of cash inflow- PV of cash outflow. So,

Initial Investment

= Purchase cost of new machine - sale value of current machine viz 50000-5000= $45000

So since the present vlue s negative i.e. -3175 $, The replacement must not be done.

Particulars Cash Flows Year PVF @ 8% PV of Cash Flows

Initial Investment

= Purchase cost of new machine - sale value of current machine viz 50000-5000= $45000

(45000) 0 1 (45000) Saving in operating Cost = 69500-60500= $9000 9000 1 to 5 3.993 35937 Saving in Maintainance cost at year 2 $2500 2500 2 .857 2142.50 Terminal Value of new machine i.e. $ 5500 5500 5 .681 3745.50 Present value of Replacement (3175)

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