Cubbies Pty Ltd is considering the purchase of a new machine to replace an old machine.Selected cost data pertaining to the two machines is provided below.At the end of four years,the company plAns to discontinue the product line for which the machines are used.Income taxes can be ignored.Calculate the net present value of the new machine,if Cubbies Pty Ltd's hurdle rate is 14 per cent.

Question

Quizplus · Accepted Answer

To calculate the net present value, we need to calculate the present value of cash inflows and outflows of both machines, and then subtract the present value of the old machine from the present value of the new machine.

For the old machine:

Cash inflows:
- Salvage value at the end of 4th year = $10,000
= $10,000/(1+0.14)^4 = $5,034.62

Cash outflows:
- Cost of old machine = $25,000
= $25,000/(1+0.14)^0 = $25,000

NPV of old machine = $5,034.62 - $25,000 = -$19,965.38

For the new machine:

Cash inflows:
- Annual revenue = $18,000
- Annual operating cost savings = $4,000
- Salvage value at the end of 4th year = $20,000

Year Cash inflows PV factor @ 14% PV of cash inflow 
0 -40,000 1 (40,000) 
1 18,000 0.8772 15,703 
2 18,000 0.7695 13,852 
3 18,000 0.675 12,150 
4 42,000 (20,000+22,000) 0.5921 24,787 
Total 46,492

Cash outflows:
- Cost of new machine = $40,000

NPV of new machine = $46,492 - $40,000 = $6,492

Therefore, the net present value of the new machine is $6,492 - $25,000 = -$18,508.

Since the net present value of the new machine is negative, it is not a good investment according to a hurdle rate of 14 per cent. So, the best choice is to keep using the old machine.

Cubbies Pty Ltd Is Considering the Purchase of a New