Question

X Company is unhappy with a machine that they bought just a year ago for $43,000. It is considering replacing it with a new machine that will save significant operating costs. Operating costs with the current machine are $66,000 per year; operating costs with the new machine are expected to be $44,000 per year. Both machines will last for 6 more years.The current machine can be sold immediately for $5,000 but will have no salvage value at the end of 6 years. The new machine will cost $68,000 and have a salvage value of $2,500 in 6 years.

Assuming a discount rate of 4%, what is the net present value of replacing the current machine?

Answer 1

Saving in operating cost=old machine operating cost -new machine operating cost=66000-44000=22000

Net initial investment = cost of new machine -cost of old machine=68000-5000=63000

Incremental salvage value at 6 year =2500

As tax rate is not given there will be no calculations for the depreciation.because there is no effect on the cash flows from depreciation.

NPV=(PVAF at 4% for 6 year*annual savings+PVIF at 4% at year*salvage value)-initial outflow

=(5.2421*22000+0.7903*2500)-63000

=115327+1976-63000=54303

Replacement of machine is viable option.company should replace the existing machine.