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    Replacement Decision- Unequal Lives

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    Filkins Fabric Company is considering the replacement of its old, fully depreciated knitting machine. Two new models are available: Machine 190-3, which has a cost of $190,000, a 3-year expected life, and after-tax cash flows (labor savings and depreciation) of $87,000 per year; and Machine 360-6, which has a cost of $360,000, a 6-year life, and after-tax cash flows of $98,300 per year. Knitting machine prices are not expected to rise, because inflation will be offset by cheaper components (microprocessors) used in the machines. Assume that Filkins' cost of capital is 14%. Should the firm replace its old knitting machine and if so, which new machine should it use. Give supporting evidence.

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    Solution Preview

    Please see the attached file.

    Since the two machines have unequal lives, we will calculate equivalent annual cash flows

    Machine 190-3

    Initial investment= $190,000
    Annual cash flow= $87,000

    We first calculate the Present value of annuity to be received each year years and then subtract the initial outlay to calculate ...

    Solution Summary

    Answers whether the firm should replace its old knitting machine and if so, which new machine should it use by calculating equivalent annual cash flows for the two alternatives (machines).

    $2.19

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