When to replace an asset: Nemo Haulers is considering whether to purchase a new

Question

When to replace an asset: Nemo Haulers is considering whether to purchase a new mini tractor for moving furniture within its warehouse. Nemo calculates that its current mini tractor generates $3,100 of cash flow per year. A new mini tractor would cost $3,000 and would provide cash flow of $4,000 per year for five years. What is the equivalent annual cash flow for the new mini tractor (round to the nearest dollar), and should Nemo purchase the new tractor? Assume the cost of capital for Nemo is 10 percent.

Explanation / Answer

First we need to compute NPV of the new tractor:

NPV= cash flow x PVIFA(n, R) – initial investment

       = 4000 x PVIFA(5,10%) – 3000

      = 4000 x 3.790787 -3000

      =12,163.15

Equivalent annual cash flow = npv/ PVIFA(n,R)

                                                   = 12,163.15 / 3.790787

                                                   = 3208.61 or 3209

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