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 $7,000.
• The old equipment was purchased 3 years ago for $20,000. It can be sold immediately for $10,000 but will have zero disposal value in 6 years.
• Maintenance work, costing $2,500, will be necessary on the new equipment in Year 4.
• 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.]

A: $1,141

B: $1,518

C: $2,019

D: $2,685

E: $3,571

F: $4,750

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	$50,000	1	$50,000
Sale value of old equipment	0	-$10,000	1	-$10,000
Maintenance of new equipment	4	$2,500	0.792	$1,980
Present value of cash outflows (A)				$41,980
Cash Inflows:
Annual cost savings	1-6	$8,500	4.917	$41,795
Difference in Salvage value of old and new machine	6	$7,000	0.705	$4,935
Present value of cash Inflows (B)				$46,730
NPV (B-A)				$4,750

Hence option F is correct.