Eastbay Hospital has an auxiliary generator that is used when power failures occur. The generator is worn out and must be either overhauled or replaced with a new generator. The hospital has assembled the following information:
Present Generator New Generator
Purchase cost new $ 24,000 $ 30,000
Remaining book value $ 17,000 -
Overhaul needed now $ 16,000 -
Annual cash operating costs $ 15,500 $ 10,500
Salvage value-now $ 12,000 -
Salvage value-eight years from now $ 11,000 $ 22,000
If the company keeps and overhauls its present generator, then the generator will be usable for seven more years. If a new generator is purchased, it will be used for seven years, after which it will be replaced. The new generator would be diesel-powered, resulting in a substantial reduction in annual operating costs, as shown above.
The hospital computes depreciation on a straight-line basis. All equipment purchases are evaluated using a 12% discount rate. (Ignore income taxes.)
Required:
1. Determine the net present value using the total-cost approach. (Any cash outflows should be indicated by a minus sign. Round discount factor(s) to 3 decimal places and intermediate calculations to nearest dollar amount.)
2. Using the incremental approach, determine the net present value in favor (or against) purchasing the new generator. (Round discount factor(s) to 3 decimal places.)