Question

Computing net present value of alternate investments LO P3

Interstate Manufacturing is considering either replacing one of its old machines with a new machine or having the old machine overhauled. Information about the two alternatives follows. Management requires a 8% rate of return on its investments. Use the (PV of $1, FV of $1, PVA of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)

Alternative 1: Keep the old machine and have it overhauled. If the old machine is overhauled, it will be kept for another five years and then sold for its salvage value.

Cost of old machine	$	104,000
Cost of overhaul		149,000
Annual expected revenues generated		94,000
Annual cash operating costs after overhaul		38,000
Salvage value of old machine in 5 years		24,000

Alternative 2: Sell the old machine and buy a new one. The new machine is more efficient and will yield substantial operating cost savings with more product being produced and sold.

Cost of new machine	$	295,000
Salvage value of old machine now		31,000
Annual expected revenues generated		101,000
Annual cash operating costs		23,000
Salvage value of new machine in 5 years		13,000

Required:

1. Determine the net present value of alternative 1. Initial cash investment (net) Chart values are based on: Year Subsequent Cash inflow (outflow) X Table factor Present Value 1 2 4 2. Determine the net present value of alternative 2. Initial cash investment (net) Subsequent Year Cash inflow X Table factor (outflow) Present Value 4 5 1 Now 3. Which alternative should management select?

Answer 1

1	Determine the net present value of alternative 1
	initial cash investment(net)					149,000
	Chart values are based on:
	i=	8%
	Year	subsequent	*	Table	=	Present
		cash inflow		Factor		value
		(outflow)
	1	56000		0.9259	=	51850
	2	56000		0.8573	=	48009
	3	56000		0.7938	=	44453
	4	56000		0.735	=	41160
	5	80000		0.6806	=	54448
						239920
	Present value of cash inflows					239920
	present value of cash outflows					149,000
	net present value					90920
(note if present value of cash outflows need to be shown negative please change it
1	Determine the net present value of alternative 2
	initial cash investment(net)					295,000
	Chart values are based on:
	i=	8%
2	Year	subsequent	*	Table	=	Present
		cash inflow		Factor		value
		(outflow)
	1	78000		0.9259	=	72220
	2	78000		0.8573	=	66869
	3	78000		0.7938	=	61916
	4	78000		0.735	=	57330
	5	91000		0.6806	=	61935
	now					31000
						351271
	Present value of cash inflows					351271
	present value of cash outflows					295,000
	net present value					56271
3	which alternative should management select
	Alternative 1