Question

Darcy Roofing is faced with a decision. The company relies very heavily on the use of its 60-foot extension lift for work on large homes and commercial properties. Last year, Darcy Roofing spent $67,200 refurbishing the lift. It has just determined that another $31,000 of repair work is required. Alternatively, it has found a newer used lift that is for sale for $132,500. The company estimates that both lifts would have useful lives of 6 years. The new lift is more efficient and thus would reduce operating expenses by about $22,400 per year. Darcy Roofing could also rent out the new lift for about $8,000 per year. The old lift is not suitable for rental. The old lift could currently be sold for $19,500 if the new lift is purchased. Prepare an incremental analysis for the life of the machines showing whether the company should replace the equipment.

Answer 1

Darcy should replace the lift

Step-by-step explanation:

Scenario 1: Darcy Roofing keeps the old lift

refurbishing costs ($31,000)

no other changes in revenues or costs*

net cash flow = ($31,000)

*The $67,200 spent repairing the lift the previous year are considered sunk costs because they cannot be recovered regardless of what decision the company makes.

Scenario 2: Darcy Roofing purchases a newer lift

cost of newer lift ($132,500)

salvage value of old lift $19,500

reduced costs per year x 6 years = $22,400 x 6 = $134,400

additional rental income x 6 years = $8,000 x 6 = $48,000

net cash flow = $69,400**

**Since we are not given any discount rate, we cannot discount the cash flows to determine the present value of the project. With a discount rate of 0, the NPV of purchasing the lift is much higher than the alternative of keeping the old lift.