Question

X Company is unhappy with a machine that they bought just a year ago for $43,000. It is considering replacing it with a new machine that will save significant operating costs. Operating costs with the current machine are $68,000 per year; operating costs with the new machine are expected to be $46,000 per year. Both machines will last for 5 more years.The current machine can be sold immediately for $7,000 but will have no salvage value at the end of 5 years. The new machine will cost $75,000 and have a salvage value of $2,000 in 5 years.

Assuming a discount rate of 7%, what is the net present value of replacing the current machine?

Answer 1

hi, please find below the answer let me know if you need any clarification -

We have not been provided with any tax rate and hence, we have removed tax implication on cash flow from our calculation
Step-1	Computation of initial investment
	Cost of new machine		75000
	Less sales price of old machine		-7000
	Initial investment =		68000
Step-2	Saving in operating cost
	Operating cost of old machine		68000
	Operating cost of new machine		46000
	Saving in operating cost		22000
Table of yearly cash flow
	Year	Year-0	Year-1	Year-2	Year-3	Year-4	Year-5
i	intial investment	-68000
ii	Saving in operating cost		22000	22000	22000	22000	22000
iii	Salvage value of new machine						2000
iv=i+ii+iii	Net incremental cash flow	-68000	22000	22000	22000	22000	24000
v	PVIF @ 7%	1.0000	0.9346	0.8734	0.8163	0.7629	0.7130
vi=iv*v	Annual cash flow	(68,000.00)	20,560.75	19,215.65	17,958.55	16,783.69	17,111.67	23,630.32
NPV =	23,630.32
Hence, net present value of replacement =		23,630.32