Question

g production machine tool. The new machine would cost $3700, have a life of four years, have no salvage value, and save the firm $500 per year in direct labor cost and $200 per year indirect labor costs. The existing machine tool was purchased four years ago at a cost of $4000. It will last four more years and have no salvage value at the end of that time. It could be sold now for $1000 cash. Assume money is worth 8%, and that the difference in taxes, insurance, and so forth, for the two alternatives is negligible. Determine whether or not the new machine should be purchased

Answer 1

The new machine should NOT be purchased.

Step-by-step explanation:

Annual total cost saving = Direct labor cost saving + Indirect labor costs saving = $500 + $200 = $700

Using the formula for calculating the present value of an ordinary annuity, the present value of the annual total cost saving can be calculated as follows:

PV = P * ((1 - (1 / (1 + r))^n) / r) …………………………………. (1)

Where;

PV = Present value the total annual cost saving = ?

P = Total annual cost saving = $700

r = interest rate = 8%, or 0.08

n = number of years = 4

Substitute the values into equation (1), we have:

PV = $700 * ((1 - (1 / (1 + 0.08))^4) / 0.08)

PV = $2,318.49

Net present value of new machine tool = – Cost of the new machine tool + PV = – $3700 + $2,318.49 = – $1,381.51

Salvage value existing machine tool now = $1,000

Since the Salvage value existing machine tool now is $1,000 while the Net present value of new machine tool is –$1,381.51, the new machine should NOT be purchased.