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 $14,000 Final sales value 2,850 Operating costs 62,180 New equipment Purchase cost $164,000 Final sales value 2,850 Operating costs 29,730 The current and new equipment will last for 6 years. If X Company replaces the current equipment, what is the approximate internal rate of return (enter your rate as a decimal; so 1% would be .01)

Explanation / Answer

Saving in Cost is 32450 per annum which is total $194700 from 6 year more than Incremental Initial Outflow $150000, Hence machine should be replaced but subject to cost of capital which is not given.

Sum of PVF at IRR = Initial Incremental Outflow/Annual Cost Saving

= $150000/$32450 = 4.6225

IRR =8% Because if we discount incremental Cashflow at 8% then NPV will be Zero.

Existing New Incremental Initial Outflow $14,000.00 $164,000.00 $150,000.00 Annual Operating Cost $62,180.00 $29,730.00 -$32,450.00 Salvage at year 6 $2,850.00 $2,850.00 $0.00

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