Question

CI Judgment Case 5-5 (Static) Replacement decision (LO5-3, 5-8] Hughes Corporation is considering replacing a machine used in the manufacturing process with a new, more efficient model. The purchase price of the new machine is $150,000 and the old machine can be sold for $100,000. Output for the two machines is identical; they will both be used to produce the same amount of product for five years. However, the annual operating costs of the old machine are $18,000 compared to $10,000 for the new machine. Also, the new machine has a salvage value of $25,000, but the old machine will be worthless at the end of the five years. You are deciding whether the company should sell the old machine and purchase the new model. You have determined that an 8% rate properly reflects the time value of money in this situation and that all operating costs are paid at the end of the year. For this initial comparison you ignore the effect of the decision on income taxes. (FV of $1. PV of $1. FVA of $1. PVA of $1. FVAD of S1 and PVAD of $1) Required: 1. What is the incremental cash outflow required to acquire the new machine? (Round your answer to nearest whole dollar amount.) 2. What is the present value of the benefits of acquiring the new machine? (Round your answer to nearest whole dollar amount.) 1. Incremental cash outflow required 2. Present value

Answer 1

Solution 1:

Incremental cash outflow required = Purchase price of new machine - sale value of old machine = $150,000 - $100,000 = $50,000

Solution 2:

Present value of benefits of acquiring new machine = saving in annual operating costs * Cumulative PV factor at 8% for 5 periods + Salvage value of new machine * PV factor at 8% for 5th period

= ($18,000 - $10,000) * 3.99271 + $25,000 * 0.68058

= $48,956