Subject: Business    / Accounting    

Question

PROBLEM: 13–25 Net Present Value; Total and Incremental Approaches[LO1]

Eastbay Hospital has an auxiliary generator that is used when power failures occur. The genera- tor is worn out and must be either overhauled or replaced with a new generator. The hospital has assembled the following information:

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If the company keeps and overhauls its present generator, then the generator will be usable for eight more years. If a new generator is purchased, it will be used for eight 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 eval- uated using a 16% discount rate.

Required:

(Ignore income taxes.)

1. Should Eastbay Hospital keep the old generator or purchase the new one? Use the total-cost approach to net present value in making your decision.

2. Redo (1) above, this time using the incremental-cost approach.