Question

Tuppence Ltd uses an ageing plant whose current resale value of $200,000 is expected to reduce by $20,000 per year. The plant’s maintenance and depreciation expenses, in total, are currently $10,000, but this annual total cost is expected to increase by $15,000 per year, as the plant really does require more and more maintenance.
Tuppence Ltd knows it can buy a replacement plant anytime over the next 5 years for a price of $350,000, which it would be able to resell after 5 years of use for $40,000. (For instance, if the plant is bought at the end of year 2, it can be sold at the end of year 7.) The total annual cost of maintenance and depreciation is expected to remain stable at $25,000.
All figures in this question are after-tax. Tuppence Ltd’s cost of capital is 10 percent
Required:

(a) Calculate the net present value of the new plant and

(b) Determine the point in time when Tuppence Ltd should replace the old one with it

Answer 1

Year	Net Cash Ouflow	Discount factor	Discounted Cash Ouflow
Initial Investment	150000 (350000-200000) Newplant cost- sale proceeds of old plant	1	150000
1	25000	0.9	22500
2	25000	0.81	20250
3	25000	0.729	18225
4	25000	0.6561	16402.50
5	-15000 (25000-40000) Outflow - Salvage	0.59049	-8857.35
Net present value of new machine if acquired after selling the exisNet present value of new machine if acquired after selling the existing one			218520.20
Net present value of the New plant without selling the old plant			418520.20