Question:
Hughes Corporation is considering replacing a machine used in the manufacturing process with a new,
more efficient model. The purchase price of the new machine is $150,000 and the old machine can be
sold for $100,000. Output for the two machines is identical; they will both be used to produce the same
amount of product for five years. However, the annual operating costs of the old machine are $18,000
compared to $10,000 for the new machine. Also, the new machine has a salvage value of $25,000, but the
old machine will be worthless at the end of the five years.
Required:
Should the company sell the old machine and purchase the new model? Assume that an 8% rate properly
reflects the time value of money in this situation and that all operating costs are paid at the end of the
year. Ignore the effect of the decision on income taxes.
Answer:
Purchase price of new machine $150,000
Sales price of old machine (100,000)
Incremental cash outflow required $ 50,000
The new machine should be purchased if the present value of the savings in operating costs of $8,000
($18,000 – 10,000) plus the present value of the salvage value of the new machine exceeds $50,000.
PV = ($8,000 x 3.99271) + ($25,000 x .68058)
PV = $31,942 + 17,015
PV = $48,957
Hughes Corporation is considering replacing a machine used in the manufacturing process with a new,
more efficient model. The purchase price of the new machine is $150,000 and the old machine can be
sold for $100,000. Output for the two machines is identical; they will both be used to produce the same
amount of product for five years. However, the annual operating costs of the old machine are $18,000
compared to $10,000 for the new machine. Also, the new machine has a salvage value of $25,000, but the
old machine will be worthless at the end of the five years.
Required:
Should the company sell the old machine and purchase the new model? Assume that an 8% rate properly
reflects the time value of money in this situation and that all operating costs are paid at the end of the
year. Ignore the effect of the decision on income taxes.
Answer:
Purchase price of new machine $150,000
Sales price of old machine (100,000)
Incremental cash outflow required $ 50,000
The new machine should be purchased if the present value of the savings in operating costs of $8,000
($18,000 – 10,000) plus the present value of the salvage value of the new machine exceeds $50,000.
PV = ($8,000 x 3.99271) + ($25,000 x .68058)
PV = $31,942 + 17,015
PV = $48,957
