X Company is considering replacing one of its machines in order to save operating costs. Operating costs with the current machine are $64,000 per year; operating costs with the new machine are expected to be $49,000 per year. The new machine will cost $74,000 and will last for four years, at which time it can be sold for $2,000. The current machine will also last for four more years but will not be worth anything at that time. It cost $35,000 three years ago but is currently worth only $6,000. Assuming a discount rate of 6%, what is the incremental net present value of replacing the current machine with the new machine?
Solution:
Computation of NPV - Replacement proposal of Equipment - X Company | ||||
Particulars | Period | Amount | PV Factor | Present Value |
Cash Outflows: | ||||
Cost of new Equipment | 0 | $74,000 | 1 | $74,000 |
Sale value of old equipment | 0 | -$6,000 | 1 | -$6,000 |
Present value of cash outflows (A) | $68,000 | |||
Cash Inflows: | ||||
Annual cost savings | 1-4 | $15,000 | 3.465 | $51,975 |
Difference in Salvage value of old and new machine | 4 | $2,000 | 0.792 | $1,584 |
Present value of cash Inflows (B) | $53,559 | |||
NPV (B-A) | -$14,441 |
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