Question

X Company is considering replacing one of its machines in order to save operating costs. Operating costs with the current machine are $60,000 per year; operating costs with the new machine are expected to be $50,000 per year. The new machine will cost $68,000 and will last for six years, at which time it can be sold for $2,000. The current machine will also last for six more years but will not be worth anything at that time. It cost $34,000 three years ago but is currently worth only $4,000. Assuming a discount rate of 5%, what is the incremental net present value of replacing the current machine with the new machine?

Tries 0/3

Answer 1

Answer : Incremental net present value of replacing the current machine with the new machine = ($11,748)

Explanation:

Initial investment = Purchase cost of new machine - Current disposable value of old machine

= $68,000 -  $4,000

= $64,000

Operating cost savings = Operating costs with the Old machine - Operating costs with the New machine

= $60,000 - $50,000  = $10,000

Terminal value of of new machine = $2,000

Calculation of incremental net present value of replacing the current machine with the new machine.

PV of Operating cost savings (Operating cost savings * PVIFA 6 years , 5 %.)	($10,000 * 5.076)	$50,760
Add : PV of terminal value of of new machine (Terminal value of of new machine * PVIF 6 years , 5 %.)	($2,000 * 0.746)	$1,492
Less : Intial investment		$64,000
Incremental net present value of replacing the current machine with the new machine		($11,748)

Since incremental net present value of replacing the current machine with the new machine is negative , it is advisable to not replace the current machine

Note: The question does not state about the decimal point to be considered for PV factor . Thus in the solution standard 3 place of decimals is considered.