George\'s is considering the purchase of a new machine to replace one that was b
ID: 2759387 • Letter: G
Question
George's is considering the purchase of a new machine to replace one that was bought 2 years ago. The new machine will cost $52,000 installed mi will require a $2000 increase in inventory and a $1500 increase in accounts payable. Both machines will be depreciated on the 3 year schedule (.33,.45,.15,.07). The old machine can be sold for $20,000 or if maintained for three more years it will have a market value then of $5000. It cost $41,000 when it was new. The new machine will provide revenues of $60000 and expenses of $30,000 each of the three years of its economic life. It should then have a market value of $10,000. The old machine would provide revenues of $40,000 and expenses of $30,000 for each of the next three years also. If the company has an 18% cost of capital is the project acceptable. Show the initial investment, cashflows and the terminal value, as well as the NPV or IRR and your decision.Explanation / Answer
Cash flows for new machine:
Serial no.
Years
Cash flows
Discounting
factor @18%
Discounted
cash flows
1
0
$ 52,000
1.00000
$ (52,000)
2
0
$ 20,000
1.00000
$ 20,000
3
1-3
$ 30,000
2.17427
$ 65,228
4
3
$ 10,000
0.60863
$ 6,086
NPV
$ 39,314
1. Initial cost of $52,000 alone taken into consideration but not inventory increase and accounts payable as they have no real cash outflow.
2. Proceeds from sale of old machine of $20,000.
3. Net cash flow of $30,000 ($60,000-$30,000) for all the 3 years.
4. Proceeds from sale of new machine after its economic life for $10,000.
Cash flows for old machine:
Alphabets
Years
Cash flows
Discounting
factor @18%
Discounted
cash flows
A
1-3
$ 10,000
2.17427
$ 21,743
B
3
$ 5,000
0.60863
$ 3,043
C
NPV
$ 24,786
It is better to purchase new machine to replace as new machine proposal have higher NPV.
Note: Depreciation is not considered as there is no tax benefit because of no tax in the present question.
Serial no.
Years
Cash flows
Discounting
factor @18%
Discounted
cash flows
1
0
$ 52,000
1.00000
$ (52,000)
2
0
$ 20,000
1.00000
$ 20,000
3
1-3
$ 30,000
2.17427
$ 65,228
4
3
$ 10,000
0.60863
$ 6,086
NPV
$ 39,314
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