Question

Filkins Fabric Company is considering the replacement of its old, fully depreciated knitting machine. Two new models are available: Machine 190-3, which has a cost of $220,000, a 3-year expected life, and after-tax cash flows (labor savings and depreciation) of $97,000 per year; and Machine 360-6, which has a cost of $320,000, a 6-year life, and after-tax cash flows of $93,400 per year. Knitting machine prices are not expected to rise, because inflation will be offset by cheaper components (microprocessors) used in the machines. Assume that Filkins's cost of capital is 12%.

Calculate the two projects' extended NPVs. Do not round intermediate calculations. Round your answers to the nearest dollar.

Machine 190-3: $  

Machine 360-6: $  

Should the firm replace its old knitting machine? If so, which new machine should it use?

The firm -Select-should replace its old knitting machine with Machine 190-3should replace its old knitting machine with Machine 360-6should not replace its old knitting machineItem 3 .

By how much would the value of the company increase if it accepted the better machine? Do not round intermediate calculations. Round your answer to the nearest dollar.

$  

What is the equivalent annual annuity for each machine? Do not round intermediate calculations. Round your answers to the nearest dollar.

Machine 190-3: $  

Machine 360-6: $  

Answer 1

Net present value of Machine 190-3 = ($97,000 / 1.12) + ($97,000 / 1.12²) + ($97,000 / 1.12³) - ($220,000 / 1.12³) + ($97,000 / 1.12⁴) + ($97,000 / 1.12⁵) + ($97,000 / 1.12⁶) - $220,000 = $22,214.86

Net present value of Machine 360-6 = ($93,400 / 1.12) + ($93,400 / 1.12²) + ($93,400 / 1.12³) + ($93,400 / 1.12⁴) + ($93,400 / 1.12⁵) + ($93,400 / 1.12⁶) - $320,000 = $64,005.44

Yes, the firm should replace its old knitting machine with the machine 360-6, because its NPV is the highest among the two alternatives.

The value of the company will increase by $64,005.44 if it chooses to replace old machine with machine 360-6.

Equivalent annual annuity of Machine 190-3 = [12% * $22,214.86] / [1 - (1.12)^-6] = $5,403.23

Equivalent annual annuity of Machine 360-6 = [12% * $64,005.44] / [1 - (1.12)^-6] = $15,567.77