Question

There is a project that involves rebuilding a machine and having the machine last for five...

  1. There is a project that involves rebuilding a machine and having the machine last for five more years and an alternative project to buy a new machine which would last for ten years. A project like this is available at the end of either machine’s life – so we need to compare our alternatives using the equivalent annuity technique. The rebuild option with a five-year life will use a present value interest factor for five years to calculate the equivalent annuity. The new machine with a ten-year life will use a present value for ten years. Given these unequal lives – do you include the salvage value of the existing machine in the cash flows for the rebuild five-year option or include this salvage value in the cash flows for the new machine option?

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Answer #1

The NPV or net present value is the present value of all the future cash flows generated by its operation or by selling it which is called salvage value. Hence, the salvage value has to be considered in both the cases while finding out there NPV as they are cash inflows for the company fro the investment or initial cash outflow did for the project. Hence if there is any salvage value then it should not be ignored rather discounted using the discount factor of the project.

The post tax salvage value has to be taken into account which is a cash flow that is adjusted for a capital gain tax and then discounted by dicount factor of the respective project.

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