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 6-year useful life will be $7,000.
• The old equipment was purchased 3 years ago for $25,000. It can be sold immediately for $5,000 but will have zero disposal value in 6 years.
• Maintenance work, costing $2,000, will be necessary on the old equipment in Year 3.
• The new equipment will result in $8,500 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

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	-$5,000	1	-$5,000
Present value of cash outflows (A)				$43,000
Cash Inflows:
Annual cost savings	1-6	$8,500	4.917	$41,795
Saving in maintenance cost	3	$2,000	0.840	$1,680
Difference in Salvage value of old and new machine	6	$7,000	0.705	$4,935
Present value of cash Inflows (B)				$48,410
NPV (B-A)				$5,410