NPV Differential Analysis of Replacement Decision (LO2, 5)

The management of Essen Manufacturing Company is currently evaluating a proposal to purchase a new, innovative drill press as a replacement for a less efficient piece of similar equipment, which would then be sold. The cost of the equipment, including delivery and installation, is $175,000. If the equipment is purchased, Essen will incur a $5,000 cost in removing the present equipment and revamping service facilities.
The present equipment has a book value of $100,000 and a remaining useful life of ten years. Because of new technical improvements that have made the present equipment obsolete, it now has a disposal value of only $40,000. Management has provided the following comparison of manufacturing costs:
Present New Equipment Equipment ANnimurlvotereltowolm (UMS): boon ceo abotouonaseancvdseossance 400,000 400,000 Annual costs Direc aloe (ser Unll) ¢cccogh eo enameneegueaoceeao mbapn c c $0.075 $0.05 Overhead Depreciation (10% of asset’s book value) ..........-.--.--- $10,000 $17,500 ORS 2 a ARR ee ir ee mE ta $48,000 $20,000 Additional information follows:
* Management believes that if the current equipment is not replaced now, it will have to wait ten years before replacement is justifiable.
* Both pieces of equipment are expected to have a negligible salvage value at the end of ten years.
* Management expects to sell the entire annual production of 400,000 units.
e Essen’s cost of capital is 14 percent.
Required Evaluate the desirability of purchasing the new equipment LO.1