Question 1medco Is A Large Manufacturing Company Currently U

Question 1medco Is A Large Manufacturing Company Currently Using A La

Question 1medco Is A Large Manufacturing Company Currently Using A La

Question 1 MedCo is a large manufacturing company, currently using a large printing press in its operations, and is considering two replacements: the PDX341 and PDW581. The PDX341 costs £500,000 and has annual maintenance costs of £10,000 for the first 5 years and £15,000 for the following 5 years. After 10 years, MedCo would scrap the PDX341 (salvage value is zero). In contrast, PDW581 costs £50,000 and requires maintenance of £30,000 a year for its 10-year life. The salvage value of the PDW581 would be zero in 10 years.

MedCo must replace its current printing press because it has stopped functioning. Assume that MedCo has a 10% cost of capital and that all cash flows are after tax. Required: Use the NPV approach to calculate which replacement press is the more appropriate.

Paper For Above instruction

Introduction

The decision to replace an aging capital asset is pivotal for manufacturing firms aiming to optimize operational efficiency and minimize costs. MedCo, a prominent manufacturing company, faces such a decision regarding its existing printing press, which has ceased functioning. The company considers two potential replacements: the PDX341 and the PDW581. This paper applies the Net Present Value (NPV) method to evaluate which of the two options is financially more advantageous, given the company's cost of capital and specified cash flows.

Overview of Replacement Options

The PDX341 is a high-capacity printing press costing £500,000, with variable annual maintenance costs: £10,000 during the first five years and increasing to £15,000 thereafter. Its salvage value at the end of 10 years is zero. Conversely, the PDW581 is a more economical alternative costing only £50,000 with a uniform annual maintenance expense of £30,000 over its 10-year lifespan, also with zero salvage value at the end.

Analytical Approach: Net Present Value Calculation

The core objective is to determine which replacement offers the higher net present value, hence better financial viability. The NPV calculation involves discounting all future cash flows, including investment costs and maintenance expenses, to their present value using the company's cost of capital, set at 10%.

Calculation of NPV for PDX341

The initial investment for the PDX341 is £500,000 at year 0. The maintenance costs for the first five years are £10,000 annually, discounted to present value, and similarly for the subsequent five years at £15,000 annually. The formula used for discounting each year's maintenance costs is:

PV = Future Cash Flow / (1 + r)^t

where r is the discount rate (10%) and t is the year.

Calculations:

- Year 1-5 Maintenance costs (£10,000 annually):

PV = 10,000 * [(1 - (1 + 0.10)^-5) / 0.10] ≈ £37,858

- Year 6-10 Maintenance costs (£15,000 annually):

PV = 15,000 * [(1 - (1 + 0.10)^-5) / 0.10] / (1 + 0.10)^5 ≈ £92,738

Total present value of maintenance costs:

PV_total = £37,858 + £92,738 ≈ £130,596

The total NPV:

NPV_PDX341 = -£500,000 - PV_total ≈ -£630,596

Since the salvage value is zero, no addition is made at year 10.

Calculation of NPV for PDW581

The initial investment is £50,000. The annual maintenance costs of £30,000 are consistent across all ten years:

PV of maintenance costs:

PV = 30,000 * [(1 - (1 + 0.10)^-10) / 0.10] ≈ £184,782

Discounted back to present:

PV = £184,782 / (1 + 0.10)^0 = £184,782

Total NPV:

NPV_PDW581 = -£50,000 - £184,782 ≈ -£234,782

Again, salvage value is zero.

Analysis and Conclusion

Comparing the two NPVs:

- PDX341: approximately -£630,596

- PDW581: approximately -£234,782

Despite both options resulting in negative NPVs, which indicates a loss or unprofitable investment in pure accounting terms, the less negative value for PDW581 suggests it is the more economically viable option under the current assumptions. Given the scale of the costs and the absence of salvage value, the company might also consider non-financial factors or alternative options.

Final Recommendation

From an NPV perspective, the PDW581 outperforms the PDX341 owing to its substantially lower initial investment and comparable maintenance costs spread evenly over its lifespan. Therefore, MedCo should favor the PDW581 for replacing its aging press, potentially supplemented with operational efficiency improvements or other strategic investments.

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