Question

Macro Company owns five machines that it uses in its manufacturing operations. Each of the machines was purchased four years ago at a cost of $120,000. Each machine has an estimated life of 10 years with no expected salvage value. A new machine has become available. One new machine has the same productive capacity as the five old machines combined; it can produce 800,000 units each year. The new machine will cost $648,000, is estimated to last six years, and will have a salvage value of $72,000. A trade-in allowance of $24,000 is available for each of the old machines. These are the operating costs per unit:

Five old Machines

New Machines

Repairs

$ 0.6796

$ 0.0856

Depreciation

0.1500

0.2400

Power

0.1890

0.1036

Other operating costs

0.1620

0.0496

$ 1.1806

$ 0.4788

Ignore federal income taxes. Use the payback period method for (a) and (b).

a. Do you recommend replacing the old machines? Support your answer with computations. Disregard all factors except those reflected in the data just given.

b. If the old machines were already fully depreciated, would your answer be different? Why?

c. Using the net present value method with a discount rate of 20%, present a schedule showing whether or not the new machine should be acquired.

Answer 1

The correct answer for option a is $705,440, for (b) f the old machines were already depreciated fully, the answer would not be different, based on the pay back period method, for (c) $1602623.78234. because the NPV is positive, New machines should be acquired.

Step-by-step explanation:

Solution to the question

Given that,

(a) if the old machines are changed we get the following,

The initial cash flow = $648,000 -(5 * $24000) = $528,000

The cash flow terminal = $72,000

The net annual cash flow / the outflow of savings

Old Machine New Machines

Operating cost per unit $ 1.1806 $ 0.4788

Cost of Depreciation $ 0.1500 $0.2400

Cash cost per unit A .B $ 1.0306 $ 0.2388

The number of units 800,000 800,000

The cash outflow $824480 $191040

The savings for outflow of cash is $824480 -$ 191040 = $633440 per year

Thus,

At the year o of outflow = $528000

Year Inflow of cash

1 $633440

2. $633440

3 $633440

4 $633440

5 $633440

6. $633440 + $72,000 = $705,440

Now we make use of the pay back period which is one year since the amount of the whole initial outflow.

It is very important to replace the outdated machines.

(b) If the old machines were already depreciated fully, the answer would not be different, based on the pay back period method.

Here, cash flow is important, because depreciation is not part of cash flow, it is a part of a non-cash expense, so it is not considered.

(c) Here, if the machines are changed:

The initial cash flow becomes = $ 528,800 (this is same values for options a)

The cash flow annually = $ 633440 (same as in option a)

The present value = $633440 * The annual present value

The factors to be considered year is = 20%, number of years = 6

so,

$633440 * 3.322551011654 = $ 2106511.12822

The cash flow terminal = 72,000

The present value = 72,000 * the present value

(20%, with 6 years)

= 72,000 * 0.33489797666

= $24112.65432

The net present value =$ 2106511.12822 + $24112.65432 - 528000

= $1602623.78234

Therefore since the NPV is reading positive, new machines should be purchased.