Question

Question 27 Machine B is expected to produce the following real cash flows: Machine B CO -120 C 1 130 Cash flows C2 141 15.3 Machine C was purchased five years ago and produces an annual real cash flow of $75,000. It has no salvage value but is expected to last another five years. The company can replace machine C with machine B either now or at the end of five years. The real opportunity cost of capital is 10%. Which should it do, replace now or in 5 years? A. The company is indifferent between replacing Machine C now or in 5 years B. The company should replace Machine C now C. The company should wait and replace Machine C at the end of five years D. There is not enough information to determine whether the company should wa E. I choose not to answer.

Answer 1

		Present Value of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=Discount Rate=Cost of Capital=10%	0.1
		N=Year of Cash flow
		CASH FLOWS IF The MACHINE IS REPLACED NOW
	N	Year	0	1	2	3	4	5
	a	Initial Cash Flow	($120,000)
	b	Cash inflow from New machine (B)		$130,000	$141,000	$153,000
	c	Cash inflow from existing machine (C)		$75,000	$75,000	$75,000	$75,000	$75,000
	d=a-b-c	Incremenntal Cash Inflow	($120,000)	$55,000	$66,000	$78,000	($75,000)	($75,000)	SUM
	PV=d/(1.1^N)	Present Value of Incremental Cash Flow	($120,000)	$50,000	$54,545	$58,603	($51,226)	($46,569)	($54,647)
		Net Present Value	($54,647)
		NPV is Negative
		Hence the machine should not be replaced now
		ANSWER:
		C.The company should wait and replace machine C at the end of five years