X Company is considering replacing one of its machines in order to save operatin
ID: 2715937 • Letter: X
Question
X Company is considering replacing one of its machines in order to save operating costs. Operating costs with the current machine are $61,000 per year; operating costs with the new machine are expected to be $47,000 per year. The new machine will cost $65,000 and will last for 5 years, at which time it can be sold for $1,000. The current machine will also last for 5 more years but will not be worth anything at that time. It cost $44,000 four years ago, but its current disposal value is only $4,000. Assuming a discount rate of 9%, what is the incremental net present value of replacing the current machine with the new machine?
Explanation / Answer
Initial Investment= cost of new machine solvage value of old mahine
Initial Investment= $65,000 $4,000 = $61,000
Operating Cost Savings =Operating expenses of old machine Oprating expenses of new macine
Operating cost savings = $61,000 $47,000 =$14,000
Terminal cash flow = $1,000
Discount factor@9%
Present value of
cash inflows
1 through 6 years (Annuity)
6th year
Less: Initial Investment
Net Present Value
$14,000
1,000
3.8896
0.6500
$54,454
$650
-----------------------
$55,104
61,000
--------------------
($5,896)
---------------------
Note: Since cash savings are uniform for all the 5 years, annuity method is used.
The incremental Net Present Value of New Mchine is negative with $5,896.
Calculation of Net Present Value Years Cash inflowsDiscount factor@9%
Present value of
cash inflows
1 through 6 years (Annuity)
6th year
Less: Initial Investment
Net Present Value
$14,000
1,000
3.8896
0.6500
$54,454
$650
-----------------------
$55,104
61,000
--------------------
($5,896)
---------------------
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