Should Narex Solutions Replace Their Copying Machine?
What factors should Narex Solutions consider when deciding whether to replace their old copying machine?
A. Cost of the new machine
B. Operational expenses
C. Required rate of return
D. Potential increase in sales
E. Decrease in operational costs
Answer:
The decision to replace an old machine with a new one entails a careful assessment of the cash inflows and outflows associated with both machines over the old machine's remaining useful life. This evaluation is done through the Net Present Value (NPV) calculation that considers the machine's cost, operational expenses, and sales, and the sales price when it reaches the end of its useful life, taking into account taxation and the rate of return required by the firm. If the calculated NPV is higher for the new machine, this would point to a financially viable decision to proceed with the replacement.
The question asked is related to the financial decision on whether or not to replace an old copying machine with a new one, taking into consideration various cost factors, the company's required rate of return, and the potential increase in sales and decrease in operational costs. To evaluate whether the new machine is a good investment, we should calculate the Net Present Value (NPV) of the cash flows associated with each machine.
NPV is a capital budgeting method that reveals how much a stream of expected cash flows is worth in today's money terms considering the cost of capital (or required rate of return) – in this case, 13%.
The cash inflows and outflows associated with both the old and new machines need to be considered over the remaining life of the old machine. Tax impacts have to be considered as well because assets' acquisition costs and operational costs can typically be deducted from taxable income.
The NPV of the cash inflows and outflows related to the new machine, considering installation, operational and sales, and end-of-life selling price depreciation expense impact can be calculated. Meanwhile, the NPV of cash inflows and outflows for the old machine can be calculated based on current sales and operational costs and the projected selling price at the end of its life.
Once these calculations are done, we can then compare the two NPV values. If the NPV of the new machine is more significant, it would be a good decision to replace the old machine.