Equipment replacement decision. Birney Products, Ltd., purchased a new glazing m
ID: 2393437 • Letter: E
Question
Equipment replacement decision. Birney Products, Ltd., purchased a new glazing machine a year ago at a cost of $35,000. The machine will last the company 10 more years, after which it is expected to have a salvage value of about $2,000. Birney Products has just been approached by a sales representative selling a highly innovative computer-aided machine that costs $90,000. The computer-aided machine could increase the company's output by about 10 percent, while at the same time reduce per unit costs. Birney's engineering department has prepared the following comparative cost and revenue data ar Present machine $200,000 Computer-aided machine 220,000 Revenues from sales Less expenses Materials and Maintenance of machine 114,000 9,000 3,000 60,000 186,000 $14,000 109,000 21,000 8,400 52,000 190,400 $29,600 es reciation of machine Labor Total e Net income The computer-aided machine would have a service life of 10 years, after which it would have a salvage value of $6,000. The machine now being used has a book value of $32,000, but it can be sold for only $10,000 due to the presence of the computer-aided machine on the market. Birney Products' management is doubtful that the new machine would provide a return as great as the company's 16 percent cost of capital, due to the machine's high cost and the low resale value of the machine currently being used REQUIRED: (1) Use the total-cost approach to discounted cash flow analysis to determine whether the company should purchase the new machine (2) Repeat the computations in (1), this time using the incremental-cost approachExplanation / Answer
PVAF for 10 years @ 16% = 4.833
PVIF at 10th year @ 16% = 0.2267
(1) Total cost Approach :-
Present Machine
Computer Aided Machine
Operating Cash Flow (OCF) :-
Revenue
200000
220000
Less:- Total Exp
186000
190400
Add:- Depreciation
3000
8400
OCF
17000
38000
Present Value of OCF (A)
(17000 * 4.833)
=82161
(38000 * 4.833)
=183654
Sale value of present machine (B)
----
10000
PV of Salvage Value (C)
(2000 * 0.2267)
=453
(6000 * 0.2267)
=1360
Total Cash Inflow (D = A + B + C)
82614
195014
Cash Outflow (E)
----
90000
NPV (D – E)
82614
105014
Yes, company should purchase the new machine
(2) Incremental – Cost Approach :-
Incremental Operating cash flow (38000 – 17000)
21000
PVAF
4.833
PV of incremental OCF (21000 * 4.833) (A)
101493
Sale of Present machine (B)
10000
Salvage Value (6000 – 2000)
4000
PVIF
0.2267
PV of salvage (4000 * 0.2267) (C)
907
Cash Outflow (D)
90000
Incremental NPV (A + B + C – D)
22400
Yes, company should purchase the new machine
Present Machine
Computer Aided Machine
Operating Cash Flow (OCF) :-
Revenue
200000
220000
Less:- Total Exp
186000
190400
Add:- Depreciation
3000
8400
OCF
17000
38000
Present Value of OCF (A)
(17000 * 4.833)
=82161
(38000 * 4.833)
=183654
Sale value of present machine (B)
----
10000
PV of Salvage Value (C)
(2000 * 0.2267)
=453
(6000 * 0.2267)
=1360
Total Cash Inflow (D = A + B + C)
82614
195014
Cash Outflow (E)
----
90000
NPV (D – E)
82614
105014
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