NPV Differential Analysis of Replacement Decision The management of Taylor2 Inc. 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 $320,000. If the equipment is purchased, Taylor2 Inc. will incur a $10,000 cost in removing the present equipment and revamping service facilities. The present equipment has a net book value of $150,000 and a remaining useful life of 5 years. Because of new technical improvements that have made the present equipment obsolete, it now has a disposal value of only $70,500. Management has provided the following comparison of manufacturing costs: Annual production (units) Annual costs Direct labor (per unit) Overhead Depreciation (20% of asset's book value) Other Annual costs/expenses Additional information follows: Present Equipment New Equipment 500,000 500,000 $0.15 $0.08 $30,000 $84,600 $32,000 $42,500 Management believes that if the current equipment is not replaced now, it will have to wait 5 years before replacement is justifiable. Both pieces of equipment are expected to have a negligible salvage value at the end of 5 years. Management expects to sell the entire annual production of 500,000 units. The Company's cost of capital is 14% (use for NPV); assume initial investment and salvage receipts are realized at beginning of year 1 and cash inflows occur at the end of each year Required: 1. Use NPV and Payback period method to analyze the capital investment decision 2. Should the management opt for replacing the equipment or keep the same equipment? 3. Calculate the IRR if the management decides to purchase the new equipment To do so, lets first understand the problem in quantitative terms. Sales Book value of Old machine Disposal of Old Machine Cost of Equipment Operating Costs Depreciation Relevant/Irrelevant