Question

11. A potential replacement machine, Machine New, is expected to produce the following real cash flows: Machine New Co -120 Cash Flows ($ thousands) C1 +110 C2 +121 C3 +133 The currently used machine, Machine Old, was purchased 5 years ago for $200,000 and produces an annual real cash flow of $80,000. It has no salvage value but is expected to last another 5 years. The company can replace Machine Old with Machine New either now or at the end of 5 years. If the real opportunity cost of capital is 10%, what should the firm do? Replace now or after 5 years? o Replace after 5 years o Replace now

Answer 1

Initial Investment		-120000
incremental income
Year	Incremental cash flow	Incremental cash flow	present value of incremental cash flow at 10% = incremental cash flow/(1+r)^n
0			-120000
1	110000-80000	30000	27272.7273
2	121000-80000	41000	33884.2975
3	133000-80000	53000	39819.6844
net present value	sum of present value of cash flow		-19023.291
No machine should not be replaced as it results in negative cash flow

Replace after 5 years