Question

A product is being manufactured on a machine that has a book value of $10,000 (20 years ago it was purchased for $50,000). The costs of the product are as follows:

Item	Unit Costs
Labor, direct	4.00
Labor, variable indirect	5.00
Other variable overhead	2.50
Fixed overhead	2.50
Total	14.00

In the past year 10,000 units were produced and sold for $10 per unit. It is expected that the old machine can be used indefinitely in the future and that the price will continue to be $10 per unit.

An equipment manufacturer has offered to accept the old machine as a trade-in for a new version. The new machine would cost $80,000, after allowing $15,000 for the old equipment. The projected costs associated with the new machine are as follows:

Item	Unit Costs
Labor, direct	2.00
Labor, variable indirect	3.50
Other variable overhead	4.00
Fixed overhead	3.25
Total	12.75

The fixed overhead costs are allocations from other department plus the depreciation of the old equipment. Repair costs are the same for both machines.

The old machine could be sold on the open market now for $6,000.

Ten years from now, it is expected to have a salvage value of $1,000. The new machine has an expected life of 10 years and an expected salvage of $10,000.

There are no corporate income taxes. The appropriate time discount rate for this company is 5%. It is expected that future demand for the product will remain at 10,000 units per year.

Evaluate whether the new equipment should be acquired. (Focus on the change in unit cost, and see whether purchasing the new machine will have the company make more money, and whether that amount justify the cost of the new machine)

Answer 1

Statement showing NPV

Particulars	0	1	2	3	4	5	6	7	8	9	10	NPV
Cost of new machine	-80000
Savings in cost (10000 * (14-12.75))		12500	12500	12500	12500	12500	12500	12500	12500	12500	12500
Salvage value(10000-1000)											9000
Total cash flow	-80000	12500	12500	12500	12500	12500	12500	12500	12500	12500	21500
PVIF @ 5%	1.00	0.95	0.91	0.86	0.82	0.78	0.75	0.71	0.68	0.64	0.61
Present value	-80000	11905	11338	10798	10284	9794	9328	8884	8460	8058	13199	22047

Since NPV is positive one should purchase new machine