A company is considering replacing an old piece of equipment that is completely

Question

A company is considering replacing an old piece of equipment that is completely depreciated. One possible replacement (machine #1) has a cost of $190,000, an expected 3-year life, and positive after-tax cash flows of $87,000 per year. The other replacement (machine #2) being considered has a cost of $360,000, an expected 6-year life and positive after-tax cash flows of $98,300 per year. Assume that the company's WACC is 14%. Use a calculator and show keystrokes used.

Question 1: Find the NPV of each machine.  Check figure: NPV of machine #2 = $22,256.

Question 2: Using the replacement chain approach, find the extended NPV of machine #1.  Check figure: Extended NPV of machine #1 = $20,070.

Question 3: Using the equivalent annual annuity (EAA) approach, find the EAA of each machine.  Check figure: EAA of machine #1 = $5,161.02.

Question 4: Assuming that both projects can be repeated, which machine should be selected to replace the old equipment? Why?

Explanation / Answer

Question 1: Find the NPV of each machine.  Check figure: NPV of machine #2 = $22,256.

NPV OF MACHINE #1 = 87000*PVIFA(14%,3)

Question 1: Find the NPV of each machine.  Check figure: NPV of machine #2 = $22,256.

NPV OF MACHINE #1 = 87000*PVIFA(14%,3)

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