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 $48,000. Disposal value at the end of its 5-year useful life will be $6,000.
• The old equipment was purchased 3 years ago for $24,000. It can be sold immediately for $10,000 but will have zero disposal value in 5 years.
• Maintenance work, costing $3,000, will be necessary on the new equipment in Year 3.
• The new equipment will result in $10,000 of operating cost savings each year.

Assuming a discount rate of 7%, what is the net present value of replacing the old equipment with the new equipment?

Answer 1

Solution:

Computation of NPV - Replacement proposal of Equipment - X Company
Particulars	Period	Amount	PV Factor	Present Value
Cash Outflows:
Cost of new Equipment	0	$48,000	1	$48,000
Sale value of old equipment	0	-$10,000	1	-$10,000
Maintenance of new equipment	3	$3,000	0.816	$2,448
Present value of cash outflows (A)				$40,448
Cash Inflows:
Annual cost savings	1-5	$10,000	4.100	$41,000
Difference in Salvage value of old and new machine	5	$6,000	0.713	$4,278
Present value of cash Inflows (B)				$45,278
NPV (B-A)				$4,830