Carlson Manufacturing has some equipment that needs to be rebuilt or replaced.The following information has been gathered relative to this decision: Carlson uses the total cost approach to net present value analysis and a discount rate of 12%.Regardless of which option is chosen,rebuild or replace,at the end of five years Carlson Manufacturing will have no future use for the equipment. If the new equipment is purchased,the present value of the cash flows that occur now is:

Question

Carlson Manufacturing has some equipment that needs to be rebuilt or replaced.The following information has been gathered relative to this decision:  Carlson uses the total cost approach to net present value analysis and a discount rate of 12%.Regardless of which option is chosen,rebuild or replace,at the end of five years Carlson Manufacturing will have no future use for the equipment. If the new equipment is purchased,the present value of the cash flows that occur now is:

Quizplus · Accepted Answer

To determine the present value of cash flows, we need to use the total cost approach to net present value analysis.

For the rebuild option:

- Cost of rebuild: $30,000 
- Annual operating cost: $12,000 
- Salvage value in 5 years: $0

Calculating annual cash flows:

Year 0: -$30,000 (initial cost)

Year 1-5: -$12,000

Total present value of cash flows for rebuild option: -$78,230

For the replace option:

- Cost of new equipment: $75,000 
- Annual operating cost: $8,000 
- Salvage value in 5 years: $15,000

Calculating annual cash flows:

Year 0: -$75,000 (initial cost)

Year 1-5: -$8,000

Year 5: $15,000

Total present value of cash flows for replace option: -$49,228

Since the present value of cash flows is higher for the rebuild option, it is the better choice. Therefore, the answer is B, rebuild.

Carlson Manufacturing Has Some Equipment That Needs to Be Rebuilt