Question - Interstate Manufacturing is considering either replacing one of its old machines with a new machine or having the old machine overhauled. Information about the two alternatives follows. Management requires a 10% rate of return on its investments.

Alternative 1: Keep the old machine and have it overhauled. If the old machine is overhauled, it will be kept for another five years and then sold for its salvage value.

Cost of old machine        $112,000

Cost of overhaul               150,000

Annual expected revenues generated  95,000

Annual cash operating costs after overhaul          42,000

Salvage value of old machine in 5 years                  15,000

Alternative 2 Sell the old machine and buy a new one. The new machine will be more efficient and will yield substantial operating cost savings with more products produced and sold.

Cost of new machine     $300,000

Salvage value of old machine now            29,000

Annual expected revenues generated  100,000

Annual cash operating costs        32,000

Salvage value of new machine in 5 years               20,000

1. Determine the net present value of alternative 1.

2. Determine the net present value of alternative 2.

3. Which alterative do you recommend management select? Explain.