Question

X Company is considering replacing one of its machines in order to save operating costs. Operating costs with the current machine are $66,000 per year; operating costs with the new machine are expected to be $49,000 per year. The new machine will cost $70,000 and will last for 6 years, at which time it can be sold for $4,000. The current machine will also last for 6 more years but will have zero salvage value. Its current disposal value is $4,000. Assuming a discount rate of 8%, what is the net present value of replacing the current machine? [Note: For the capital budgeting questions, use the Present Value tables in the Coursepack or with the link after the last question  A: $12,915 B: $15,111 C: $17,680 D: $20,685 E: $24,202 F: $28,316

Answer 1

Answer:

Correct option is B. $15111.

Explanation:

Step 1:

Intial Cash Investment = Cost of New Machine - Current Replace cost of old Machine

= $70000 - $4000

= $66000

Step 2:

Annual savings in cost = $66000 - $49000 = $17000

Present Value of Annual savings = $17000 x Present Value Annuity factor(r,n) + Salvage Value x Present Value interest factor(r,n)

= $17000 x Present Value Annuity factor(8%,6) + $4000 x Present Value interest Factor(8%,6)

= $17000 x 4.623 + $4000 x 0.630

= $78591 + $2520

= $81111

Step 3:

Net Present Value = Present Value of Annual savings - Intial Cash Investment

= $81111 - $66000

= $15111.