X Company must decide whether to continue using its current equipment or replace

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 $5,000 Final sales value 2,500 Operating costs 63,000 New equipment Purchase cost $46,000 Final sales value 5,000 Operating cost savings 9,000 Maintenance work will be necessary on the current equipment in Year 4, costing $2,000. The current equipment will last for 5 more years; the life of the new equipment is also 5 years. Assuming a discount rate of 5%, what is the net present value of replacing the current equipment?

Explanation / Answer

Net present value = PV of cash inflow - Initial cash outflow PV of cash inflow = $9000*PVIFA @5% 5 years+$5000*PVIF @5% 5 years + $2000*PVIF @5% 4 years = ($9000*4.3295)+($5000*0.7835)+($2000*0.8227) = $38965.29+$3917.63-$1645.41 = $44528.32 Initial cash outflow = Purchase cost of new equipment - current sale value old equipment = $46000-$5000 = $41000 NPV = $44528.32-$41000 = $3528.32 Since the NPV is positive it is suggested to buy the new machine

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