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Project evaluation - maximum price that can be paid

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The company decides to buy the new equipment to replace the existing equipment which was acquired five years ago at a cost of $5,000,000.
The existing equipment is expected to provide eight more years of service if major repairs of $588,000 are performed three years from now. Annual cash operating costs total $3,000,000 and are not expected to change in future periods. The estimated market value of the existing equipment in eight years is $735,000. Your company may sell the existing equipment now for $3,528,000 and buy the new equipment.

The new equipment has a service life of eight years, is expected to reduce operating costs by $882,000 annually, and has an estimated residual value of $2,646,000. Major repairs of $220,500 for the new equipment will be necessary at the end of the fifth year of operation.

If IRR is 15%, would you please tell me how to find out the maximum price that the company would be willing to pay for the new equipment?

Thank you.

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Detailed solution attached.

Solution provided by:
Sonia Agarwal, CA
Education
  • Chartered Accountant (Equivalent to CPA in US), Institute of Charted Accountants of India
  • Bachelor of Commerce, West Bengal University
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