the purchase of a new ock Company manufactures metal garbage containers. Crock i

Question

the purchase of a new ock Company manufactures metal garbage containers. Crock is considering stamping machine. The current residual value of Crock's existing stamping machine is $15,000. The new machine would cost $70,000 and would have a residual value of $5,000 at the end of its 12- year life. The annual operating costs of the new machine would be $7,000. Crock's other option is to rebuild the existing machine. The rebuilding would cost $30,000 and would extend the life of the existing machine by 12 years. The rebuilt machine would have annual operating costs of $11,000 per year and residual value of $2,000 at the end of the 12 years. Crock uses a hurdle rate of 8% to make capital budgeting decisions. Using net present value analysis, how much better (or worse) off will Crock be if rather than rebuilding the existing machine, Crock sells the existing machine and purchases the new machine? Better off by $4,350 Worse off by $8,665 Worse off by $7,129 Better off by $6,335 None of the above

Explanation / Answer

The answer is "Better of by $6,335"

When new machine is purchased then cash outflow for purchase = 70,000 - 15,000 = $55,000 (out flow)

Present value of residual value of $ 5,000 after 12 years = $1,986 (in flow)

Present value of annual operating costs of $7,000 for 12 years = $52,753 (out flow)

So, if new machine is purchased then net out flow = $105,767

But, if existing machine is rebuild then, cash out flow for rebuilding = $30,000 (out flow)

Present value of annual operating costs of $11,000 for 12 years = $82,897 (out flow)

Present value of residual value of 2,000 after 12 years = $795

So, if existing machine is rebuild then net out flow = $112,102

As a result if Crock sells the existing machine and purchases the new machine, then it will be Better of by $6,335

(105,767 - 112,102)

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