Question - Interstate Manufacturing is considering either replacing one of its old machines with a new machine or having the old machine overhauled. Information about the two alternatives follows. Management requires a 10% rate of return on its investments.
Alternative 1: Keep the old machine and have it overhauled. If the old machine is overhauled, it will be kept for another five years and then sold for its salvage value.
Cost of old machine $112,000
Cost of overhaul 150,000
Annual expected revenues generated 95,000
Annual cash operating costs after overhaul 42,000
Salvage value of old machine in 5 years 15,000
Alternative 2 Sell the old machine and buy a new one. The new machine will be more efficient and will yield substantial operating cost savings with more products produced and sold.
Cost of new machine $300,000
Salvage value of old machine now 29,000
Annual expected revenues generated 100,000
Annual cash operating costs 32,000
Salvage value of new machine in 5 years 20,000
1. Determine the net present value of alternative 1.
2. Determine the net present value of alternative 2.
3. Which alterative do you recommend management select? Explain.