Case Scenario:
Adele Corp. is considering the replacement of some electric generating equipment by a more efficient, technologically advanced model. The new equipment costs $110,000 but the vendor has agreed to provide a trade-in allowance on the existing equipment of $35,000. The present equipment has a remaining useful life of 4 years and the new equipment would also be retired at the end of its 4th year of service. Given the expected level of future operations, the existing equipment's operating costs are projected at $40,000 per year. The new equipment is expected to result in saving of operating costs of $20,000 per year. The current equipment would have a $40,000 salvage value at the end of its useful life, while the proposed equipment's salvage value is estimated to be $20,000. The desired rate of return on investments is 10%.
Q1. What is the NPV of retaining the existing equipment?
Q2. What is the NPV of replacing the existing equipment?
Q3. Which alternative should the Company choose, and why?