CASE NO.

3 – SINCLAIR COMPANY
A. EQUIPMENT REPLACEMENT

1. Assuming the present equipment has zero book value and zero salvage value, should
the company buy the proposed equipment.

Years Cash 15% Present

Flows Factor Value
Initial Investment Now (250,000) 1 (250,000)

Annual net cash inflows 1-5 72,000 3.352 241,344

Net Present Value (8,656.00)

Decision: NPV Outflow > NPV Inflow.

Do not purchase.
A. EQUIPMENT REPLACEMENT

2. Assuming the present equipment is being depreciated at a straight-line rate of 10

percent, that it has a book value of $135,000 (cost, $225,000; accumulated
depreciation, $90,000), and has zero net salvage value today, should the company
buy the proposed equipment?
Years Cash 15% Present
Flows Factor Value
Initial Investment Now (250,000) 1 (250,000)

Annual net cash inflows 1-5 72,000 3.352 241,344

Net Present Value (8,656.00)

Decision: NPV Outflow > NPV Inflow.

Do not purchase.
A. EQUIPMENT REPLACEMENT

3. Assuming the present equipment has a book value of $135,000 and a salvage value
today of $75,000 and that if retained for 5 more years its salvage value will be zero,
should the company buy the proposed equipment?
A. EQUIPMENT REPLACEMENT

4. Assume the new equipment will save only $37,500 a year, but that its economic life
is expected to be 10 years. If other conditions are as described in (1) above, should
the company buy the proposed equipment?
B. REPLACEMENT FOLLOWING EARLIER REPLACEMENT

Sinclair Company decided to purchase the equipment described in Part A (hereunder

called “Model A” equipment). Two years later, even better equipment (called “Model B”)
comes on the market and makes the other equipment completely obsolete, with no
resale value. The model B equipment cost $500,000 delivered and installed, but it is
expected to result in annual savings of $160,000 over the cost of operating the model A
equipment. The economic life of model B is estimated to be 5 years. Taxes are to be
disregarded,

What action should the company take?

B. REPLACEMENT FOLLOWING EARLIER REPLACEMENT

Model A Years Cash Flows 15% Factor Present Value

Investment in
Equipment Now $ (250,000.00) 1 $ (250,000.00)
Annual Net Cash
Inflows 1-2 $ 72,000.00 1.626 $ 117,072.00
Net Present Value $ (132,928.00)

Model B Years Cash Flows 15% Factor Present Value

Investment in
Equipment Now $ (500,000.00) 1 $ (500,000.00)
Annual Net Cash
Inflows 1-5 $ 160,000.00 3.352 $ 536,320.00
Net Present Value $ 36,320.00
B. REPLACEMENT FOLLOWING EARLIER REPLACEMENT
Investment $500,000
Annual earnings $160,000
Present value of $1 a year, 5 years, 15 percent 3.352
Present value: $160,000 x 3.352 $536,320

NET PRESENT VALUE $36,320

Decision: NPV: $536,320 - $500,000 = $36,320; therefore, Purchase.
Note: If Model A has resale value, the return would be even higher.
C. CHANGE IN EARNINGS PATTERN

Assume that the savings are expected to be $79,500 in each of the first three years and
$60,750 in each of the next two years, other conditions remaining as described in Part
A (1).
1. What action should the company take?
C. CHANGE IN EARNINGS PATTERN

Assume that the savings are expected to be $79,500 in each of the first three years and
$60,750 in each of the next two years, other conditions remaining as described in Part
A (1).
2. Why is the result here different from that in Part A (1)?