You are operating an old machine that is expected to produce a cash inflow of $5

Question

You are operating an old machine that is expected to produce a cash inflow of $5,000 in each of the next 3 years before it fails. You can replace it now with a new machine that costs $20,000, but is much more efficient and will provide a cash flow of $10,000 a year for 4 years. a) What is the NPV of the purchase of the new machine if you take into account only the incremental cash flows it can generate relative to the old machine? Given your computations, should you replace the old machine now? b) What is the EAA of the new machine if you look only at the cash flows associated to that machine? Does that computation suggest that you should replace your old equipment now?

Explanation / Answer

Solution.

a) What is the NPV of the purchase of the new machine if you take into account only the incremental cash flows it can generate relative to the old machine? Given your computations, should you replace the old machine now?

NO, In this condition old machine should not change.

Note :- For calculation of NPV we have must should be a discounting factore.

Year Cash Flow 0       (20,000) 1            5,000 2            5,000 3            5,000 4            5,000 Total    20,000.00

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