Q 2. Gens Enterprises is studying the replacement of some equipment that originally cost R74,000. The equipment is expected to provide six more years of service if R8,700 of major repairs are performed in two years. Annual cash operating costs total R27,200. Gens can sell the equipment now for R36,000; the estimated residual value in six years is R5,000.
New equipment is available that will reduce annual cash operating costs to R21,000. The equipment costs R103,000, has a service life of six years and has an estimated residual value of R13,000. Company sales will total R430,000 per year with either the existing or the new equipment. Gens has a minimum desired return of 12% and depreciates all equipment by the straight-line method.
Required:
1. By using the net-present-value method, determine whether Gens should keep its present equipment or acquire the new equipment. Round all calculations to the nearest Rand and ignore income.
2. Gens's management feels that the time value of money should be considered in all long-term decisions. Briefly discuss the rationale that underlies management's belief.
Q 2. Gens Enterprises is studying the replacement of some equipment that originally cost R74,000. The equipment is expected to provide six more years of service if R8,700 of major repairs are performed in two years. Annual cash operating costs total R27,200. Gens can sell the equipment now for R36,000; the estimated residual value in six years is R5,000.
New equipment is available that will reduce annual cash operating costs to R21,000. The equipment costs R103,000, has a service life of six years and has an estimated residual value of R13,000. Company sales will total R430,000 per year with either the existing or the new equipment. Gens has a minimum desired return of 12% and depreciates all equipment by the straight-line method.
Required:
1. By using the net-present-value method, determine whether Gens should keep its present equipment or acquire the new equipment. Round all calculations to the nearest Rand and ignore income.
2. Gens's management feels that the time value of money should be considered in all long-term decisions. Briefly discuss the rationale that underlies management's belief.
Related questions
This is a decision to keep or replace current equipment, mutually exclusive alternatives. The question asks for the difference in the net present values of the two alternatives, not the net present value of one or the other. Use the present value tables on page 118 to compute present values.
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Nautical Creations is one of the largest producers of miniature ships in a bottle. An especially complex part of one of the ships needs special production equipment that is not useful for other products. The company purchased this equipment early in 2012 for $200,000. It is now early in 2015, and the manager of the Model Ships Division, Jeri Finley, is thinking about purchasing new equipment to make this part. The current equipment will last for six more years with zero disposal value at that time. It can be sold immediately for $40,000. The following are last year's per-unit manufacturing costs, when production was 7,600 ships:
| Direct materials | $3.60 |
| Direct labor | 3.55 |
| Variable overhead | 1.55 |
| Fixed overhead | 4.70 |
| Total unit cost | $13.40 |
The cost of the new equipment is $145,000. It has a six year useful life with an estimated disposal value at that time of $35,000. The sales representative selling the new equipment stated, "The new equipment will allow direct labor and variable overhead to be reduced by $2.25 per unit." Finley thinks this estimate is accurate, but also knows that a higher quality of direct material will be necessary with the new equipment, costing $0.17 more per unit. Fixed overhead costs will decrease by $4,300.
Finley expects production to increase to 8,000 ships in each of the next six years. Assume a discount rate of 5%.
REQUIRED
1. What is the difference in net present values if Nautical Creations buys the new equipment instead of keeping their current equipment?
