Filkins Fabric Company is considering replacing its old, fully depreciated knitting machine. Two...

Question:

Filkins Fabric Company is considering replacing its old, fully depreciated knitting machine. Two new models are available: Machine 190-3, which has a cost of $190,000, a 3-year expected life, and after-tax cash flows (labor savings and depreciation) of $87,000 per year; and Machine 360-6, which has a cost of $360,000, a 6-year life, and after-tax cash flows of $98, 300 per year. Knitting machine prices are not expected to rise, because inflation will be offset by cheaper components (microprocessors) used in the machines. Assume that Filkins' cost of capital is 14%.

Calculate the two projects' NPVs. Round your answers to the nearest cent.

Should the firm replace its old knitting machine, and, if so, which new machine should it use? By how much would the value of the company increase if it accepted the better machine? Round your answer to the nearest cent.

What is the equivalent annual annuity for each machine? Round your answer to the nearest cent.

Net Present Value:

"Net Present Value" is the difference between the total present value of asset and initial cost of asset. The cost of equity or discount rate is used to calculate the net present value of asset during the given period of time.

Answer and Explanation:

1) Net Present Value of Machine 190-3 is calculated below:

Initial cost of Machine = $190,000

Annual after-tax cash flows (labor savings and depreciation) = $87,000

Period = 3 Years

Discount rate = 14%

Net Present Value of Machine 190-3 = $87,000*PVIFA( 14%, 3 Years) - Initial cost of Machine

= $87,000*2.32163 - $190,000

= $201,982 - $190,000

=$ 11,982

2) Net Present Value of Machine 360-6 is calculated below:

Initial cost of Machine = $360,000

Annual after-tax cash flows (labor savings and depreciation) = $98,300

Period = 6 Years

Discount rate = 14%

Net Present Value of Machine 360-6 = $98,300*PVIFA( 14%, 6 Years) - Initial cost of Machine

= $98,300*$3.8886675 - $360,000

= $382256 - $360,000

= $22,256

3)Old knitting machine should replace old knitting machine because the both machine hav positive NPV and out of two new machines the Machine 360-6 should be used if you want to accept the better machine then previous one then the NPV of machine should be more than $22,256


Learn more about this topic:

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How to Calculate Net Present Value: Definition, Formula & Analysis

from Financial Accounting: Help and Review

Chapter 5 / Lesson 20
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