X Company must decide whether to continue using its current equipment or replace
ID: 2575054 • 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:
Maintenance work will be necessary on the new equipment in Year 3, 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 7%, what is the net present value of replacing the current equipment?
Current equipment Current sales value $5,000 Final sales value 3,500 Operating costs 65,000 New equipment Purchase cost $48,000 Final sales value 6,000 Operating cost savings 9,000Explanation / Answer
Calculation of present value of cash out flows:
Particulars
Amount
Purchase price of new machine
$48,000
Less: current sale value of current machine
$5,000
p.v of cash outflow in Year 1
$43,000
P.V of Cash out flow in year 3 = $3,000*p.v factor @ 7% at 3rd year
P.V of Cash out flow in year 3 = $3,000*0.81629
$2,449
Total Cash outflows (43,000+2,449)
$45,449
Calculation of present value of cash inflows:
Annual operating savings
$9,000
Annuity factor @ 7% for 6 years
4.76653966
P.V of cash inflows from savings (9,000*4.7665)
$42,899
P.v of inflows from final sale value = $6,000*P.v factor @ 7% st 6th year
P.v of inflows from final sale value = $6,000*0.66634
$3,998
Total Cash Inflows (42,899+3,998)
$46,896.91
Ans
Net present value = P.V of cashinlows - p.v of cash outflows
NPV = 46,896.91-45,449
$1,448.02
Calculation of present value of cash out flows:
Particulars
Amount
Purchase price of new machine
$48,000
Less: current sale value of current machine
$5,000
p.v of cash outflow in Year 1
$43,000
P.V of Cash out flow in year 3 = $3,000*p.v factor @ 7% at 3rd year
P.V of Cash out flow in year 3 = $3,000*0.81629
$2,449
Total Cash outflows (43,000+2,449)
$45,449
Calculation of present value of cash inflows:
Annual operating savings
$9,000
Annuity factor @ 7% for 6 years
4.76653966
P.V of cash inflows from savings (9,000*4.7665)
$42,899
P.v of inflows from final sale value = $6,000*P.v factor @ 7% st 6th year
P.v of inflows from final sale value = $6,000*0.66634
$3,998
Total Cash Inflows (42,899+3,998)
$46,896.91
Ans
Net present value = P.V of cashinlows - p.v of cash outflows
NPV = 46,896.91-45,449
$1,448.02
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