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:

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)

Current equipment    Current sales value $16,000    Final sales value 3,620    Operating costs 68,100 New equipment    Purchase cost $166,000    Final sales value 3,620    Operating cost savings 27,690

Explanation / Answer

SOLUTION.

Calculation for decision maling.

Purchase cost of new machine - Current sales value of machine = $166,000 - $16,000 = $150,000

Investment = $150,000.

Cash flow = Current opereting cost - New opereting cost = $68,100 - $27,690 = $40,410

IRR = Investment / Cash flow

= $150,000 / $40,410 = 3.7119 = 15%

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