Equipment replacement decision Birney Products Ltd purchased

Equipment replacement decision. Birney Products, Ltd., purchased a new glazing machine a year ago at a cost of $35,000. The machine will last the company 10 more years, after which it is expected to have a salvage value of about $2,000. Birney Products has just been approached by a sales representative selling a highly innovative computer-aided machine that costs $90,000. The computer-aided machine could increase the company\'s output by about 10 percent, while at the same time reduce per unit costs. Birney\'s engineering department has prepared the following comparative cost and revenue data ar Present machine $200,000 Computer-aided machine 220,000 Revenues from sales Less expenses Materials and Maintenance of machine 114,000 9,000 3,000 60,000 186,000 $14,000 109,000 21,000 8,400 52,000 190,400 $29,600 es reciation of machine Labor Total e Net income The computer-aided machine would have a service life of 10 years, after which it would have a salvage value of $6,000. The machine now being used has a book value of $32,000, but it can be sold for only $10,000 due to the presence of the computer-aided machine on the market. Birney Products\' management is doubtful that the new machine would provide a return as great as the company\'s 16 percent cost of capital, due to the machine\'s high cost and the low resale value of the machine currently being used REQUIRED: (1) Use the total-cost approach to discounted cash flow analysis to determine whether the company should purchase the new machine (2) Repeat the computations in (1), this time using the incremental-cost approach

Solution

PVAF for 10 years @ 16% = 4.833

PVIF at 10^th year @ 16% = 0.2267

(1) Total cost Approach :-

Present Machine

Computer Aided Machine

Operating Cash Flow (OCF) :-

Revenue

200000

220000

Less:- Total Exp

186000

190400

Add:- Depreciation

3000

8400

OCF

17000

38000

Present Value of OCF (A)

(17000 * 4.833)

=82161

(38000 * 4.833)

=183654

Sale value of present machine (B)

----

10000

PV of Salvage Value (C)

(2000 * 0.2267)

=453

(6000 * 0.2267)

=1360

Total Cash Inflow (D = A + B + C)

82614

195014

Cash Outflow (E)

----

90000

NPV (D – E)

82614

105014

Yes, company should purchase the new machine

(2) Incremental – Cost Approach :-

Incremental Operating cash flow (38000 – 17000)

21000

PVAF

4.833

PV of incremental OCF (21000 * 4.833) (A)

101493

Sale of Present machine (B)

10000

Salvage Value (6000 – 2000)

4000

PVIF

0.2267

PV of salvage (4000 * 0.2267) (C)

907

Cash Outflow (D)

90000

Incremental NPV (A + B + C – D)

22400

Yes, company should purchase the new machine

	Present Machine	Computer Aided Machine
Operating Cash Flow (OCF) :-
Revenue	200000	220000
Less:- Total Exp	186000	190400
Add:- Depreciation	3000	8400
OCF	17000	38000
Present Value of OCF (A)	(17000 * 4.833) =82161	(38000 * 4.833) =183654
Sale value of present machine (B)	----	10000
PV of Salvage Value (C)	(2000 * 0.2267) =453	(6000 * 0.2267) =1360
Total Cash Inflow (D = A + B + C)	82614	195014
Cash Outflow (E)	----	90000
NPV (D – E)	82614	105014