Question

X Company is unhappy with a machine that they bought just a year ago for $40,000. It is considering replacing it with a new machine that will save significant operating costs. Operating costs with the current machine are $64,000 per year; operating costs with the new machine are expected to be $42,000 per year. Both machines will last for 6 more years.The current machine can be sold immediately for $4,000 but will have no salvage value at the end of 6 years. The new machine will cost $70,000 and have a salvage value of $1,500 in 6 years.

Assuming a discount rate of 7%, what is the net present value of replacing the current machine?

Answer 1

Note :

• Saving in operating costs due to replacement

= Operating costs with the current machine - Operating costs with the new machine = $64,000 - $42,000 = $22,000

• Intial outlay = Cost of new machine - Sales of current machine = $70,000 - $4,000 = $66,000

Answer :

Computation of Net present value

Particulars	Working	Present value ($)
Intial outlay		(66,000)
Saving in operating costs : $22,000 * PVIFA(7%, 6 years)	$22,000 * 4.76654	104,864
Salvage value of new machine : $1,500*PVIF(7%, 6 years)	$1,500 * 0.66634	1,000
Net present value		$39,864

Net present value of replacing the current machine : $39,864