11.12 Dean Manufacturing Company is considering the replacement of an old. relat

Question

11.12 Dean Manufacturing Company is considering the replacement of an old. relatively ineffi- cient vertical drill machine that was purchased seven years ago at a cost of $10,000. The ma- chine had an original expected life of 12 years and a zero estimated salvage value at the end of that period. The current market value of the machine is $1.000. The divisional manager re- ports that a new machine can be bought and installed for $12.000. Over its five-year life. this machine will expand sales from $10.000 to $11.500 a year and, furthermore, will reduce labor and raw-materials usage sufficiently to cut annual operating costs from $7.000 to $5.000. The new machine has an estimated sal- vage value of $2.000 at the end of its five-year life. The firm's MARR is 15%. (a) Should the new machine be purchased now? (b) What current market value of the old ma- chine would make the two options equal? I am confused as to how this question will be solved. I would like to see the complete steps. DO NOT JUST MENTION THE TABLES. l am in the learning phase I have to know the steps to solve many more questions.

Explanation / Answer

Solution:

(a.)

For solving questions like mentioned above, we need to calculate the results in differential forms, like incremental revenue, incremental expenses, savings in expenses or cost, increase in depreciation, etc.which are calculated by subtracting the results of old investment or equipment from the results of new investment or equipment.

This can further be explained as under with the help of schedule prepared below.

(.b)

The current price of the machine should be, $ 1,000 + $ 2,184.04 = $ 3,184.04 in order to make the two options equal, as

Here, NPV is 0, therefore both te options are equal.

Purchase price of new machine 12,000 Less: Sale proceeds from Old machine 1,000 Cash Outflow 11,000

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