X Company is considering replacing one of its machines in order to save operatin

Question

X Company is considering replacing one of its machines in order to save operating costs. Operating costs with the current machine are $61,000 per year; operating costs with the new machine are expected to be $50,000 per year. The new machine will cost $71,000 and will last for 6 years, at which time it can be sold for $1,500. The current machine will also last for 6 more years but will not be worth anything at that time. It's currently worth $7,000. Assuming a discount rate of 7%, what is the incremental net present value of replacing the current machine with the new machine?

Explanation / Answer

Old Machine Present Cost = $ 7,000

New Machine Present Cost = $ 71,000

Difference = 7,000 - 71,000 = - $ 64,000

Now Incremental CashFlows :

Year 1 = 61000 - 50000 = $11,000

Year 2 = 61000 - 50000 = $11,000

Year 3 = 61000 - 50000 = $11,000

Year 4 = 61000 - 50000 = $11,000

Year 5 = 61000 - 50000 = $11,000

Year 6 = 61000 - 50000 + 1,500 = $12,500

so

NPV = - 64,000 + 11,000/1.07 + 11,000/1.07^2 + 11,000/1.07^3 + 11,000/1.07^4 + 11,000/1.07^5 + 12,500/1.07^6

NPV = - 64,000 + 11,000*4.1 + 12,500/1.07^6

NPV= - $ 10,568.55 ...................(answer)

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