K&G Company currently sells 1.00 million units per year of a product to one customer at a price of $3.60 per unit. The customer requires that the product be exclusive and expects no increase in sales during the five-year contract. The company manufactures the product with a machine that it purchased seven years >>30 at a cost of $738,000. Currently, the machine has a book value of $447,000 but the market value is only $243,000.
The machine is expected to last another five years, after which it will have no salvage value. Last year, the production variable costs per unit were as follows:
Direct materials $1.80
Direct labour 0.90
variable Overheads 0.30
Total variable Cost per unit $3.00
The company president is considering replacing the old machine with a new one that would cost $601, 500. The new machine is expected to last five years.
At the end of that period, the savage value will be $335,000. The president expects to save 4% of the company's total variable costs with the new machine.
Assume that the company's desired rate of return is 11%. Using the net present value method, calculate the net present value of the investment. Should the company replace the old machine with the new one?