Question

X Company is considering replacing one of its machines in order to save operating costs. Operating costs with the current machine are $68,000 per year; operating costs with the new machine are expected to be $38,450 per year. The new machine will cost $156,000 and will last for five years, at which time it can be sold for $3,000. The current machine will also last for five more years but will not be worth anything at that time. It cost $45,000 four years ago, but its current disposal value is only $6,000. Assuming a discount rate of 8%, what is the incremental net present value of replacing the current machine?

b. 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

	New Machine Cost	156000
	Curent cost of old machine	6000
	Net outflow	150000	(156000-6000)
	Operating Cost with curent Machine	68000
	Operating Cost with new machine	38450
	Annual Net Saving	29550	(68000-38450)
	Expected Life	5	years
	Salavage Value new machine	3000
	Cost of capital	8%
A
		a	b			c=a*b
	Year	Amount	PV Factor@8%			Present Value
	0	-150000	1			(150,000)
	1 to 5	29550	3.9927	=PV(8%,5,-1,0,0)	Present value annuity @8% for 5years	117,985
	5	3000	0.6806	=(1/1.08)^5	Present value @8% for 5th year	2,042
				NPV		(29,974)
	Since incremental NPV is negative machine should not be replaced.
B
		a	b			c=a*b
	Year	Amount	PV Factor@8%			Present Value
	0	-150000	1			(150,000)
	1 to 6	29550	4.6229	=PV(8%,6,-1,0,0)	Present value annuity @8% for 6years	136,606
				NPV		(13,394)
	Since incremental NPV is negative machine should not be replaced.
	IRR Calculation
	Year	Cashflow
	0	-150000
	1	29550
	2	29550
	3	29550
	4	29550
	5	29550
	6	29550
	IRR	5%	=IRR(C325:C331)