Answer:
The correct answer for option a is $705,440, for (b) f the old machines were already depreciated fully, the answer would not be different, based on the pay back period method, for (c) $1602623.78234. because the NPV is positive, New machines should be acquired.
Explanation:
Solution to the question
Given that,
(a) if the old machines are changed we get the following,
The initial cash flow = $648,000 -(5 * $24000) = $528,000
The cash flow terminal = $72,000
The net annual cash flow / the outflow of savings
Old Machine New Machines
Operating cost per unit $ 1.1806 $ 0.4788
Cost of Depreciation <u> $ 0.1500 </u> <u> $0.2400
</u>
Cash cost per unit A .B $ 1.0306 $ 0.2388
The number of units 800,000 800,000
The cash outflow $824480 $191040
The savings for outflow of cash is $824480 -$ 191040 = $633440 per year
Thus,
At the year o of outflow = $528000
Year Inflow of cash
1 $633440
2. $633440
3 $633440
4 $633440
5 $633440
6. $633440 + $72,000 = $705,440
Now we make use of the pay back period which is one year since the amount of the whole initial outflow.
It is very important to replace the outdated machines.
(b) If the old machines were already depreciated fully, the answer would not be different, based on the pay back period method.
Here, cash flow is important, because depreciation is not part of cash flow, it is a part of a non-cash expense, so it is not considered.
(c) Here, if the machines are changed:
The initial cash flow becomes = $ 528,800 (this is same values for options a)
The cash flow annually = $ 633440 (same as in option a)
The present value = $633440 * The annual present value
The factors to be considered year is = 20%, number of years = 6
so,
$633440 * 3.322551011654 = $ 2106511.12822
The cash flow terminal = 72,000
The present value = 72,000 * the present value
(20%, with 6 years)
= 72,000 * 0.33489797666
= $24112.65432
The net present value =$ 2106511.12822 + $24112.65432 - 528000
= $1602623.78234
Therefore since the NPV is reading positive, new machines should be purchased.
