Interstate Manufacturing is considering either overhauling an old machine or replacing it with a new machine. Information about the two alternatives follows. Management requires a 8% rate of return on its investments. (PV of $1, FV of $1, PVA of $1, and FVA of $1)
Alternative 1: Keep the old machine and have it overhauled. This requires an initial investment of $151,000 and results in $61,000 of net cash flows in each of the next five years. After five years, it can be sold for a $20,000 salvage value.
Alternative 2: Sell the old machine for $32,000 and buy a new one. The new machine requires an initial investment of $293,000 and can be sold for a $7,000 salvage value in five years. It would yield cost savings and higher sales, resulting in net cash flows of $51,000 in each of the next five years.
Required:
1. Determine the net present value of alternative 1.
2. Determine the net present value of alternative 2.
3. Which alternative should management select based on net present value?