Question

ABC Boat Company is interested in replacing a molding machine with a new improved model. The old machine has a salvage value of $10,000 now and a predicted salvage value of $4,000 in six years, if rebuilt. If the old machine is kept, it must be rebuilt in one year at a predicted cost of $20,000. The new machine costs $80,000 and has a predicted salvage value of $12,000 at the end of six years. If purchased, the new machine will allow cash savings of $20,000 for each of the first three years, and $10,000 for each year of its remaining six-year life. What is the net present value of purchasing the new machine if the company has a required rate of return of 14%?

Answer 1

1.Computation of Net Present value of Purchasing new machine

If the company purchased the new machine,then old machine have to be sold.In that cost Initial net cash outflow will be;

=Cost of new machine-salvage value of old machine

=$80,000- $10,000

=$70,000

Further, if new machine purchsed,there will be additional cash saving of $20,000(i.e Cost of rebuilt of old machine) and loss of salvage value of old machine at 6th year

Accordingly,Present value of net cash flows are as follows;

Year	Cash flows(a)	Present value of $1 at 14%(b)	Present value(a*b)
1	($20000+$20000)=$40,000	.8772	35,088
2	$20,000	.7695	15,390
3	$20,000	.6750	13,500
4	$10,000	.5921	5,921
5	$10,000	.5914	5,914
6	($10,000+12000-4000)=$18,000	.4556	8,201
Sum of Present value	$84,014

NPV of New Machine

=Sum of Present value-Initial cash outlay

=$84,014-$70,000

=14,014

Thus net present value of purchasing the new machine is $14,014