Company makes decision to purchase the new equipment to replace existing equipment that was obtained five years ago at a cost of $5,000,000.
Research fee $80,000 was spent last year for new equipment. Information of existing equipment and proposed new equipment are given as follows:
Existing equipment is expected to give eight more years of service if major repairs of $588,000 are performed three years from now. Annual cash operating costs total= $3,000,000 and are not expected to change in future periods. Estimated market value of existing equipment in eight years is $735,000. Company may sell existing equipment now for $3,528,000 and purchase new equipment.
New equipment has the service life of eight years, is expected to decrease operating costs by $882,000 annually, and has the estimated residual value of $2,646,000. Major repairs of $220,500 for new equipment will be necessary at the end of fifth year of operation. Moreover, to finance new equipment, it seems that your company would have to borrow $3,000,000 at 7% interest annually from OPEN Bank.
If IRR is 15%, tell me how to determine maximum price that company would be eager to pay for new equipment? Ignore taxes.