Question

X Company is trying to decide whether to continue using old equipment to make Product A or replace it with new equipment that will have lower operating costs. The following information is available: The new equipment will cost $50,000. Disposal value at the end of its 6-year useful life will be $5,500. The old equipment was purchased 3 years ago for $21,000. It can be sold immediately for $10,000 but will have zero disposal value in 6 years. Maintenance work, costing $4,000, will be necessary on the new equipment in Year 3. The new equipment will result in $9,000 of operating cost savings each year. Assuming a discount rate of 6%, what is the net present value of replacing the old equipment with the new equipment? [Note: Use the Present Value tables in the Coursepack.]

Answer 1

	Statement for calculating NPV of replacing old equipment with new one
	Particulars	Amount	Discounting factro	PV
Outflow	New equipment cost	-50000	1	-50000
Inflow	Disposl value at end of 6th year	5500	0.7049605	3877.283
	(Discounting factor, 6% 6the year)		=1/(1.06)^6
Inflow	Sale of old equipment	10000	1	10000
	(sold at time 0, PV factor = 1)
Outflow	Maintenance cost at end of 3rd year	-4000	0.8396193	-3358.48
	(Discounting factor, 6% 3rd year)		=1/(1.06)^3
	Operating cost savings each year	9000	4.9173	44255.7
	( PV of Annuity , 6%, 6 years)
	*(calculation attached in picture of annuity)
	Net present value			4774.506