Question

X Company is trying to decide whether to continue using old equipment to make Product A or replace it with new equipment that will have lower operating costs. The following information is available:

• The new equipment will cost $48,000. Disposal value at the end of its 6-year useful life will be $7,000.
• The old equipment was purchased 3 years ago for $25,000. It can be sold immediately for $5,000 but will have zero disposal value in 6 years.
• Maintenance work, costing $2,000, will be necessary on the old equipment in Year 3.
• The new equipment will result in $8,500 of operating cost savings each year.

Assuming a discount rate of 6%, what is the net present value of replacing the old equipment with the new equipment? [Note: Use the Present Value tables in the Coursepack.]

Answer 1

Calculation of Present Value if equipment replaced
Year	Cash Flow	Present value factor @6%	Presnt Value
0	-43000	1.0000	(43,000)
1	8500	0.9434	8,019
2	8500	0.8900	7,565
3	10500	0.8396	8,816
4	8500	0.7921	6,733
5	8500	0.7473	6,352
6	8500	0.7050	5,992
6	7000	0.7050	4,935
	Net present value	5,411
	net present value of replacing the old equipment with the new equipment is $5411
Caluclation of Cash Flow
Year	Cost of Buying new equipment	Salvage value of old equipment	Operating Cost saving due to new equipment	Maintenance Cost saving due to new equipment	SALVAGE VALUE OF NEW EQUIPMENT	Total
0	-48000	5000				-43000
1			8500			8500
2			8500			8500
3			8500	2000		10500
4			8500			8500
5			8500			8500
6			8500		7000	15500