Question

2. Determine the net present value of alternative 2 1. Determine the net present value of alternative 1. Initial cash investment (net) 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 12% rate of return on its investments (PV of $1. FV of $1. PVA of $1. and FVA of $1) (Use appropriate factor(s) from the tables provided.) Initial cash investment (net) Chart values are based on: Year Subsequent Cash inflow (outflow) Table factor Present 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 Year Subsequent Cash inflow (outflow) Table factor - Present Value 2 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 $119,00 149.000 90,000 34,000 23,000 2 Now 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 $382,000 34,000 108,000 26,000 15,000 3. Which alternative should management select? Required: 2. Determine the net present value of alternative 2. Initial cash investment (net) 1. Determine the net present value of alternative 1. Year Subsequent Cashx Inflow (outflow) Table factor Present Value

Answer 1

Answer Determination of Net Present Value of Alternative 1 Initial Cash Investment (net) $149,000 Chart values are based on: 12% Subsequent Year Cash inflow X Table factor = Present Value (outflow) $56,000 0.8929 $50,002 $56,000 0.7972 $44,643 $56,000 0.7118 $39,861 $56,000 0.6355 $35,588 $79,000 0.5674 $44,825 $214,919 Present Value of Cash Inflows Present Value of Cash Outflows Net Present Value $214,919 ($149,000) $65,919 Subsequent Cash inflow(1 - 4) = $90,000 - $34,000 = $56,000 Subsequent Cash inflow(5 yr) = $56,000 + $23,000 = $79,000

Determination of Net Present Value of Alternative 2 Initial Cash Investment (net) $302,000 Chart values are based on: i= 12% Year Subsequent Cash inflow (outflow) x Table factor = Present Value $82,000 $82,000 $82,000 $82,000 $97,000 $34,000 0.8929 0.7972 0.7118 0.6355 0.5674 $73,218 $65,370 $58,368 $52,111 $55,038 $34,000 $338,105 $338,105 ($302,000) $36,105 Now Present Value of Cash Inflows Present Value of Cash Outflows Net Present Value Subsequent Cash inflow(1-4) = $108,000 - $26,000 = $82,000 Subsequent Cash inflow(5 yr) = $82,000 + $15,000 = $97,000 The Management should select Alternative 1.