Columbia Enterprises is studying the replacement of certain equipment which originally cost $74,000. The equipment is expected to give six more years of service if $8,700 of major repairs is 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 which will decrease annual cash operating costs to $21,000. The equipment costs $103,000, consists of 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 consists of a minimum desired return of 12% and depreciates all equipment by using the straight-line method.
Instructions:
By utilizing the net-present-value method, find out whether Columbia must keep its present equipment or acquire the new equipment. Round all computations to the closest dollar and ignore income taxes. Columbia's management feels that the time value of money must be considered in all long-term decisions. In brief describe the rationale which underlies management's belief.