Question

A company is considering the installation of a new machine at a cost of $60000 to replace a machine purchased 7 years ago for $100000. The disposal value of the old machine is $15000. Both machines will have similar outputs and will produce work of identical quality. The estimated yearly costs of operating old machine is $22,000 and that of new machine is $11,000.

Both machines have an estimated remaining life of 3 years, at which time both machines will have a zero estimated disposal value. Assume that:

i) the required rate of return is 10 percent per annum.

ii) the operating costs of the old machine and the new machine are incurred at the end of each year.

(a) Calculate the NPV of the cash flows associated with old machine.

(b) Calculate the NPV of the cash flows associated with new machine.

(c) Should the company purchase the new machine, or continue to operate the old one?

Answer 1

Given

Old Machine

Cost of Machine- $100000

Life of Machine- 10 years

Today's Disposal Value of machine- $ 15000

Remaining Life left- 3 years

Operating Cost per year- $22000

After 3 years Disposal value of machine- $0 (Zero Dollar)

New Machine

Cost of Machine- $ 60000

Operating Cost per year- $11000

Disposal Value- $0 (Zero Dollar)

Life of the Machine- 3 years

Required rate of return @ 10% per annum for both machines

A)

Net Present Value of Old Machine
Year	Cash Flows	PVF	Present Value
0	40500	1	40500
1	22000	0.909090909	20000
2	22000	0.826446281	18181.81818
3	22000	0.751314801	16528.92562
Net Present Value			95210.7438

Working Notes
			Amount in $
Year	Value of Machine	Depreciation	Book Value of Machine
0	100000	0	100000
1	100000	8500	91500
2	91500	8500	83000
3	83000	8500	74500
4	74500	8500	66000
5	66000	8500	57500
6	57500	8500	49000
7	49000	8500	40500
Depreciation	=	Cost of Machine - Disposal Value
		Life of Machine
	=	100000 - 15000
		10
	=	85000
		10
	=	$      8,500.00

B)

Net Present Value of New Machine
Year	Cash Flows	PVF	Present Value
0	60000	1	60000
1	11000	0.909091	10000
2	11000	0.826446	9090.909091
3	11000	0.751315	8264.46281
Net Present Value			87355.3719

C) As per the comparison of the NPV of both machine New Machine have less cash outflow rather than the old machine. So Company should replace the old machine with new one as new machine has less cash outflow.