If Company A is considering the replacement of its old, fully depreciated knitti

Question

If Company A is considering the replacement of its old, fully depreciated knitting machine. Two new models are available: Machine 190-3, which has a cost of $219,000, a 4-year expected life, and after-tax cash flows (labor savings and depreciation) of $98,200 per year; and Machine 360-6, which has a cost of $322,000, a 8-year life, and after-tax cash flows of $94,500 per year. Knitting machine prices are not expected to rise, because inflation will be offset by cheaper components (microprocessors) used in the machines. Assume that the companies cost of capital is 12.70%.

What is the equivalent annual annuity of Machine 190-6?
Should the company replace the old machine? Which machine should be chosen?

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Explanation / Answer

Hi,

Please find the detailed answer as follows:

NPV = -219000 + 98200/(1+.1270)^1 + 98200/(1+.1270)^2 + 98200/(1+.1270)^3 + 98200/(1+.1270)^4 = $74923.19

Equivalent Annual Annuity = 74923.19/PVIFA(12.70%,4 Years) = 74923.19/2.9931 = $25031.97

Thanks.

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