- 10 Marks
MA – May 2018 – L2 – Q1a – Discounted cash flow
Compare the NPV of maintaining old equipment versus buying new equipment to advise management on the better option.
Question
The Maintenance Manager of Prudence Ltd insists that management should maintain an old equipment that had been used for 5 years and is fully depreciated rather than buy a new one. The old equipment has a current operating cost of GH¢53,000.00 per annum. The operating cost of the equipment is expected to increase at 5% every year over the next four years, with a sale value of GH¢6,500.00 in the fifth year.
The Maintenance Manager has proposed, that a new system with enhanced technology to reduce operating cost to GH¢32,000.00 for the next three years and GH¢33,600.00 for the fourth and fifth years be introduced. The new equipment will cost GH¢60,000.00 and when introduced, a redundancy cost of GH¢25,000.00 will be paid, with the old equipment sold for GH¢12,000.00. The sale value of the new equipment will be GH¢10,200.00 after its five years’ useful life.
Required:
Using Net Present Value (NPV) method of capital appraisal with 20% cost of capital, advise management on which option Prudence Ltd should go for.
Find Related Questions by Tags, levels, etc.
- Tags: Capital Appraisal, Equipment Investment, Net Present Value, Operating Costs
- Level: Level 2
- Topic: Discounted cash flow
- Series: MAY 2018