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 $70,000 per year; operating costs with the new machine are expected to be $46,000 per year. The new machine will cost $71,000 and will last for 6 years, at which time it can be sold for $1,000. The current machine will also last for 6 more years but will not be worth anything at that time. It's currently worth $5,000. Assuming a discount rate of 7%, what is the incremental net present value of replacing the current machine with the new machine?

Explanation / Answer

Current Costs :

Old Machine = $ 5000

New Machine = $ 71,000

Difference = 5000 - 71000 = - $ 66,000

Benefits:

Year 1 = 70,000 - 46,000 = $24,000

Year 2 = 70,000 - 46,000 = $24,000

Year 3 = 70,000 - 46,000 = $24,000

Year 4 = 70,000 - 46,000 = $24,000

Year 5 = 70,000 - 46,000 = $24,000

Year 6 = 70,000 - 46,000 + 1,000 = $25,000

so

Incremental NPV = - 66,000 + 24,000/1.07 + 24,000/1.07^2 +.....24,000/1.07^5 + 25,000/1.07^6

Incremental NPV = -66,000 + 24,000*4.1 + 25,000/1.07^6

Incremental NPV = $ 49,063.29

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