Question

ABC Is considering an investment in a machine that will generate costs and savings as shown Machine Cost ( 10 year life) $500,000 Current Monthly Costs Monthly Costs w new machine 12,000.00 6,500.00 The required rate of return is 8% Compute the n pv, npv index and the irr of the above CCP can purchase a new pckg machine in lieu of its current machine Old Machine New Machine Hours per year 4,000 4,000 Cost per hour Years of use sale of old machine Annual repairs Cost of New Machine 5.60 4.2 5 2,500 2,600 800 14,000 Prepare a differential analysis

Answer 1

SOLUTION:

(A)

Total monthly inflow=12000-6500

                            =5500

Yearly Cash inflow= 5500x12             

                           = 66000

NPV= Present value of cash flow - initial investment

       = $ 66000 X (1-(1+8%)^-10) ÷ 8% - $500000

       = $ 66000X (1-1.08^-10) ÷ 8% - $500000

       = $ 66000(1-0.46319)÷ 0.08 - $500000

       = $ 66000(0.5368) ÷ 0.08 - $500000

       = $ 442860 - $500000

       = $ (57140)

NPV INDEX = Present value of cash flow / initial investment

                  = 442860/500000

                  = 0.88572

IRR

For calculating irr,let us first calculate NPV at 5% rate of return

NPV = $ 66000 X (1-(1+5%)^-10) ÷ 5a% - $500000

        = $ 509635 - $500000

        = $ 9635

IRR = R1​+ (NPV1​×(R2​−R1​))​ / (NPV1​−NPV2​)

      = 5 + ( 9635 x(8%-6%) / (9635-(-57140))

      = 5.2885

(b)

DIFFERENTIAL ANALYSIS

PARTICULARS	OLD MACHINE	NEW MACHINE
Hourly cost	22400 (4000x5.6)	16800 (4000x4.2)
Sale of old machine	(2500)	-
Annual repairs	2600	800
Cost of new machine	-	14000
TOTAL	22500	31600

Therefore , it is not advised to purchase the new machine to earn the differential profit of $9100(31600-22500).