Question

6-38 A manufacturer is considering replacing a production machine tool. The new machine, costing $40,000, would have a life of 5 years and no salvage value, but would save the firm $5000 per year in direct

Answer 1

Step 1:We would first list down the series of cash flows if the new machinery is bought:

Cash flow 1:Capital expenditure (Outflow) of $40,000 in Year 0

Cash flow 2:Resale value (Inflow) of $15,000 of the old machinery in Year 0

Cash flow 3:Savings of $5,000 in direct labour costs(inflow) for 5 years

Cash flow 4:Savings of $2,000 in indirect labour costs (inflow) for 5 years

Step 2: We would present the cash flows along with the present values in a tabular form:

Year	Inflow	Outflow	Net cash flow	DF 10%	Present value
0	15,000	-40,000	-25,000	1	-25,000
1	7,000	-	7,000	0.91	6,364
2	7,000	-	7,000	0.83	5,785
3	7,000	-	7,000	0.75	5,259
4	7,000	-	7,000	0.68	4,781
5	7,000	-	7,000	0.62	4,346
					1,536

We see that the net cash flow is positive ($1,536). Hence, the machinery should be purchased.