Question

X Company is considering replacing one of its machines in order to save operating costs. Operating costs with the current machine are $64,000 per year; operating costs with the new machine are expected to be $35,385 per year. The new machine will cost $156,000 and will last for four years, at which time it can be sold for $1,000. The current machine will also last for four more years but will not be worth anything at that time. It cost $41,000 four years ago, but its current disposal value is only $6,000.

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

Tries 0/3

10. Assume the following two changes: 1) both machines will last for six more years, 2) the salvage value of the new machine after six years will be zero. If X Company replaces the current equipment, what is the approximate internal rate of return?

Answer 1

Solution 9:

Computation of NPV - Replacement proposal of equipment - X Company
Particulars	Period	Amount	PV Factor at 7%	Present Value
Incremental Cash Outflows:
Cost of new machine	0	$156,000.00	1	$156,000.00
Sale value of old machine	0	-$6,000.00	1	-$6,000.00
Present value of Incremental cash outflows (A)				$150,000.00
Incremental Cash Inflows:
Saving in annual operating cost	1-4	$28,615.00	3.38721	$96,925.05
Salvage value of new machine	4	$1,000.00	0.76290	$762.90
Present value of cash Inflows (B)				$97,687.95
NPV (B-A)				-$52,312.05

Solution 10:

At IRR present value of incremental cash inflows will be equal to incremental cash outflows. Lets calculate NPV at 4% discount rate.

Computation of NPV - Replacement proposal of equipment - X Company
Particulars	Period	Amount	Discount rate - 4%
			PV Factor	Present Value
Incremental Cash Outflows:
Cost of new machine	0	$156,000.00	1	$156,000.00
Sale value of old machine	0	-$6,000.00	1	-$6,000.00
Present value of Incremental cash outflows (A)				$150,000.00
Incremental Cash Inflows:
Saving in annual operating cost	1-6	$28,615.00	5.24200	$150,000.00
Present value of cash Inflows (B)				$150,000.00
NPV (B-A)				$0.00

As Present value of incremental cash inflows are equal to incremental cash outflows. Therefore internal rate of return in 4%.