Question
12. You are operating an old machine that is expected to produce a cash inflow of $5,000 in each of the next 3 years before
12. You are operating an old machine that is expected to produce a cash inflow of $5,000 in each of the next 3 years before it fails. You can replace it now with a new machine that costs $20,000, but is much more efficient and will provide a cash flow of $10,000 a year for 4 years.
a) What is the NPV of the purchase of the new machine if you take into account only the incremental cash flows it can generate relative to the old machine? Given your computations, should you replace the old machine now?
b) What is the EAA of the new machine if you look only at the cash flows associated to that machine? Does that computation suggest that you should replace your old equipment now? [Hint: the EAA of the old machine can be considered to be just the annual cash inflows it generates]
13. A new furnace for your small factory will cost $27,000 to install and will require ongoing maintenance expenditures of $1,500 a year. However, since it will be much more efficient than the furnace you have now, it will reduce your consumption of heating oil by 2,400 gallons per year. Heating oil is expected to cost on average $3.50 per gallon in the upcoming year, and that price is expected to increase by $0.50 each year for the two years that follow. From that point onwards, oil prices are expected to stabilize for the foreseeable future. The furnace will last for 20 years, at which point it will need to be replaced and will have no salvage value. The discount rate is 8%
. a) What is the payback period of the investment?
b) What is the discounted payback period of the investment?
c) What is the NPV of the investment in the furnace?
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