Question

X Company is considering replacing one of its machine: 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 $42,000 per year. The new machine will cost $66,000 and will last for six years, at which time it can be sold for $1,500. The current machine will also last for six more years but will not be worth anything at that time It cost $33,000 three years ago but is currently worth only $8,000. Assuming a discount rate of 7%, what is the incremental net present value of replacing the current machine with the new machine?

Answer 1

Net present value is difference between present value of cash inflows and cash outflows

positive net present value means that project / machine should be accepted

incremental cash flows from new machine

initial investment = new machine cost-salvage of old machine

=$66,000-$8,000

= -$58,000

incremental operating costs savings= (old machine operating cost-new machine operating cost)

($68,000-$42,000)

=$26,000

salvage value of new machine = $1,500

years	cash inflows	discount factor at 7%	present value of cash inflows
1-6	$26,000	4.7665[1/1.07]1+[1/1.07]2+[1/1.07]3+[1/1.07]4+[1/1.07]5+[1/1.07]6	$123,929 [26000*4.7665]
6	$1500	0.6663[1/1.07]6	$1000[1500*0.6663]
0	-$58,000	1	-$58,000
		Net present value	$66,929	[123929+1000-58000]

As the net present value is positive it is wise to invest in new machine.

incremental Net present value =$66,929