NPV Total and Differential Analysis of Replacement Decision (LO2)

Gusher Petro is evaluating a proposal to purchase a new processor that would cost $120,000 and have a Salvage value of $12,000 in five years. Gusher’s cost of capital is 16 percent. It would provide annual operating cash savings of $15,000, as follows:

0 = New

: Processor — Processor SIRES: 9 4 o's es Gat ob ee Ee ees erin $34,000 $44,000 Sova oi eee or 6,000 5,000 RTM Yem ew eert yc eeeg oe chiro SPNET NE Sees ok! SEY vistas’ sabiomtlegecs hen 13,000 6,000 CleanmnarancinmealmteManGGatccr concn coves cs cn atnaiten ene 22,000 5,000 Motalicashiexpendituresicfeccie suit Gk. ceciow Sowa des $75,000 $60,000 If the new processor is purchased, Gusher will sell the old processor for its current salvage value of

$30,000. If the new processor is not purchased, the old processor will be disposed of in five years at a predicted scrap value of $2,000. The old processor’s present book value is $50,000. If kept, the old processor will require repairs predicted to cost $40,000 in one year.

Required

a. Use the total cost approach to evaluate the alternatives of keeping the old processor and purchasing the new processor. Indicate which alternative is preferred.

b. Use the differential cost approach to evaluate the desirability of purchasing the new processor.

 LO.1