X Company must decide whether to continue using its current equipment or replace
ID: 2574999 • Letter: X
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 Final sales value Operating costs $10,000 4,000 68,000 New equipment Purchase cost Final sales value Operating cost savings $45,000 6,000 9,000 Maintenance work will be necessary on the current equipment in Year 4, costing $3,000. The current equipment will last for 6 more years; the life of the new equipment is also 6 years. Assuming a discount rate of 5%, what is the net present value of replacing the current equipment?Explanation / Answer
Calculation of present value of cash out flows:
Particulars
Amount
Purchase price of new machine
$45,000
Less: current sale value of current machine
$10,000
p.v of cash outflow in Year 1
$35,000
P.V of Cash out flow in year 4 = $3,000*p.v factor @5% at 4th year
P.V of Cash out flow in year 3 = $3,000*0.8227
$2,468
Total Cash outflows (35,000+2,468)
$37,468
Calculation of present value of cash inflows:
Annual operating savings
$9,000
Annuity factor @ 5% for 6 years
4.329476671
P.V of cash inflows from savings (9,000*4.32947)
$38,965
P.v of inflows from final sale value = $6,000*P.v factor @ 5% st 6th year
P.v of inflows from final sale value = $6,000*0.7835
$4,701
Total Cash Inflows (38,965+4,701)
$43,666.29
Ans
Net present value = P.V of cash inlows - p.v of cash outflows
NPV = 43,666.29-37,468
$6,198.19
Calculation of present value of cash out flows:
Particulars
Amount
Purchase price of new machine
$45,000
Less: current sale value of current machine
$10,000
p.v of cash outflow in Year 1
$35,000
P.V of Cash out flow in year 4 = $3,000*p.v factor @5% at 4th year
P.V of Cash out flow in year 3 = $3,000*0.8227
$2,468
Total Cash outflows (35,000+2,468)
$37,468
Calculation of present value of cash inflows:
Annual operating savings
$9,000
Annuity factor @ 5% for 6 years
4.329476671
P.V of cash inflows from savings (9,000*4.32947)
$38,965
P.v of inflows from final sale value = $6,000*P.v factor @ 5% st 6th year
P.v of inflows from final sale value = $6,000*0.7835
$4,701
Total Cash Inflows (38,965+4,701)
$43,666.29
Ans
Net present value = P.V of cash inlows - p.v of cash outflows
NPV = 43,666.29-37,468
$6,198.19
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