Chapter 16, Problem 40P

The supervisor of the county Department of Transportation (DOT) is considering the replacement of some machinery. This machinery has zero book value but its current market value is $800. One possible alternative is to invest in new machinery, which has a cost of $39,000. This new machinery would produce estimated annual operating cash savings of $12,500. The estimated useful life of the new machinery is four years. The DOT uses straight-line depreciation. The new machinery has an estimated salvage value of $2,000 at the end of four years. The investment in the new machinery would require an additional investment in working capital of $3,000, which would be recovered after four years.

If the DOT accepts this investment proposal, disposal of the old machinery and investment in the new equipment will take place on December 31, 20x1. The cash flows from the investment will occur during the calendar years 20x2 through 20x5.

Required: Prepare a net-present-value analysis of the county DOT’s machinery replacement decision. The county has a 10 percent hurdle rate.