X Company must decide whether to continue using its current equipment or replace
ID: 2575254 • 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 current 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 6%, what is the net present value of replacing the current equipment?
**The answer is not 3608, 544.50, or 694.50**
Current equipment Current sales value $5,000 Final sales value 3,500 Operating costs 70,000 New equipment Purchase cost $53,000 Final sales value 6,000 Operating cost savings 8,500Explanation / Answer
Net present value = PV of cash inflow - Initial cash outflow PV of cash inflow = $8500*PVIFA @6% 6 years+$6000*PVIF @6% 6 years + $3000*PVIF @6% 2 years (assume that the maintenance is at the beginning of year 3) = ($8500*4.9173)+($6000*0.705)-($3000*0.89) = $41797.26+$4229.76+$2670 = $48697 Initial cash outflow = Purchase cost of new equipment - current sale value old equipment = $53000-$5000 = $48000 NPV = $48697-$48000 = $697 Since the NPV is positive it is suggested to buy the new machine
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