- 10 Marks
FM – L2 – Q75 – Discounted cash flow
Calculate NPV to decide between maintaining old equipment or buying new equipment for Wisdom Ltd, using a 20% cost of capital.
Question
The maintenance manager of Wisdom Ltd insists that management should maintain an old piece of 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 Wisdom Ltd should go for.
Find Related Questions by Tags, levels, etc.
- Tags: Cost of Capital, Discounted cash flow, Equipment replacement, NPV, operating costs
- Level: Level 2
- Topic: Discounted cash flow
