Question

Interstate Manufacturing is considering either replacing one of its old machines with a new machine or having the old machine overhauled. Information about the two alternatives follows. Management requires a 10% rate of return on its investments. Use the PV of $1. FV of $1. PVA of $1, and FVA of $1 (Use appropriate factor(s) from the tables provided.) Alternative 1: Keep the old machine and have it overhauled. If the old machine is overhauled, it will be kept for another five years and then sold for its salvage value. Cost of old machine Cost of overhaul Annual expected revenues generated Annual cash operating costs after overhaul Salvage value of old machine in 5 years $104,600 145,000 93,000 48,000 21.000 Alternative 2: Sell the old machine and buy a new one. The new machine is more efficient and will yield substantial operating cost savings with more product being produced and sold. Cost of new machine Salvage value of old machine now Annual expected revenues generated Annual cash operating costs Salvage value of new machine in 5 years $298,000 44,000 108,000 29,000 9,000

Answer 1

1.

$145,000 Year Determining the net present value at alternative 1 Initial cash investment(net) Chart values are based on: i= 10% Subsequent cash flow (outflow) x Table factor@ 10% = 45,000 0.9091 45,000 0.8264 45,000 0.7513 45,000 0.6830 66,000 0.6209 Present value 40909.50 37188.00 33808.50 30735.00 40979.40 183620.40

Net present value=Present value of cash inflows-present value of cash outflows

Net present value=$183,620.40-$145,000

Net present value=$38,620.40

*subsequent cash flows=Annual expected revenues generated-annual cash operating costs

subsequent cash flows=$93,000-$48,000=$45,000

In 5th year the cash flows would include salvage value of $21,000.Thus, cash flows=$45,000+$21,000=$66,000.

2.

$298,000 Year Determining the net present value at alternative 2 Initial cash investment(net) Chart values are based on: i= 10% Subsequent cash flow (outflow) | Table factor@ 10% 79,000 0.9091 79,000 0.8264 79,000 0.7513 79,000 0.6830 88,000 0.6209 Present value 71818.90 65285.60 59352.70 53957.00 54639.20 305053.401

Net present value=Present value of cash inflows-Present value of cash outflows

Net present value=$305,053.40-$298,000

Net present value=$7,053.40

*subsequent cash flows=Annual expected revenues generated-annual cash operating costs

subsequent cash flows=$108,000-$29,000=$79,000

In 5th year the cash flows would include salvage value of $9,000.Thus, cash flows=$79,000+$9,000=$88,000

3.The management should select alternative 1 as the net present value in alternative 1 ($38,620.40) is greater than in alternative 2($7,053.40).