Question

EIF Manufacturing company needs to overhaul its drill press or buy a new one. The facts have been gathered, and are as follows: Current New $100,000 machine $80,000 30,000 40,000 Annual cash operating costs 70,000 20,000 5,000 Purchase price, new Current book value Overhaul needed now 40,000 Current salvage value Salvage value in five years 20,000 Required: Based on present value analysis, which alternative is the most desirable with a current required rate of return of 20 percent? Show computations, ignore tax effect.

Answer 1

fix B3 A C D Е 1 2 current machine present present value of cash flows value factor cash flows -$40,000 -$ 70,000 $5,000 -$ 40,000 overhaul needed now 4 1.00000 -$209,343 $2,009 cash operating costs 5 2.99061 salvage value of current machine 6 0.40188 net present value -$ 247,333 7 new machine present value of present cash flows value factor cash flows 10 purchase price of new machine salvage value of current machine cash operating costs salvage value of new machine -$100,000 -$100,000 $20,000 11 1.00000 $20,000 -$40,000 $20,000 12 1.00000 -$119,624 $8,038 13 2.99061 14 0.40188 net present value -$ 191,587 15 16 decision based on present value analysis, purchasing the new machine is most desirable reason because new machine's present value of net cash outflows is lower 17 18 19 N N0O O

for formulas and calculations, refer to the image below -

B3 A C D F 1 2 current machine cash flows present value factor present value of cash flows -C4*D4 -C5*D5 -C6*D6 overhaul needed now -40000 1 -PV(20%,5,1) |-PV(20%,5,0,1) 4 cash operating costs salvage value of current machine 5000 -70000 5 6 |=SUM(E4:E6) net present value 7 new machine cash flows present value factor present value of cash flows 10 purchase price of new machine -100000 salvage value of current machine 20000 cash operating costs EC11*D11 1 11 -C12* D12 1 -PV(20%,5,1) |-PV(20%,5,0,1) 12 -40000 C13*D13 13 -C14*D14 salvage value of new machine 20000 14 net present value =SUM(E11:E14) 15 16 decision based on present value analysis, purchasing the new machine is most desirable reason because new machine's present value of net cash outflows is lower. 17 18 19 N

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