Equipment replacement decision
Columbia Enterprises is studying the replacement of some equipment that originally cost $74,000. The equipment is expected to provide six more years of service if $8,700 of major repairs are performed in two years. Annual cash operating costs total $27,200. Columbia can sell the equipment now for $36,000; the estimated residual value in six years is $5,000.
New equipment is available that will reduce annual cash operating costs to $21,000. The equipment costs $103,000, has a service life of six years, and has an estimated residual value of $13,000. Company sales will total $430,000 per year with either the existing or the new equipment. Columbia has a minimum desired return of 12% and depreciates all equipment by the straight-line method.
Instructions
a. By using the net-present-value method, determine whether Columbia should keep its present equipment or acquire the new equipment. Round all calculations to the nearest dollar, and ignore income taxes.
Columbia's management feels that the time value of money should be considered in all long-term decisions. Briefly discuss the rationale that underlies management's belief.