Question

BSU Inc. wants to purchase a new machine for $35,500, excluding $1,400 of installation costs. The old machine was bought five years ago and had an expected economic life of 10 years without salvage value. This old machine now has a book value of $2,200, and BSU Inc. expects to sell it for that amount. The new machine would decrease operating costs by $7,500 each year of its economic life. The straight-line depreciation method would be used for the new machine, for a six-year period with no salvage value.
(a) Determine the cash payback period. (Round cash payback period to 1 decimal place, e.g. 10.5.)
(b) Determine the approximate internal rate of return. (Round answer to 0 decimal places, e.g. 10. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)
(c) Assuming the company has a required rate of return of 6%, determine whether the new machine should be purchased.

Answer 1

Answer:

(a) Payback period: 4.6 years;

(b) IRR: 8.45%;

(c) NPV = $2,180; machine should be purchased.

Explanation:

(a)

We have net investment outlay = Purchase cost of new machine + Installation cost of new machine - Proceed from selling old machine = 35,500 + 1,400 - 2,200 = $34,700

Payback period = Initial investment outlay/ Cost saving per year = 34,700/7,500 = 4.6 years.

(b)

IRR is the discount rate that brings NPV of the project to zero. Thus, we have:

-34,700 + (7,500/IRR) x (1- (1+IRR)^-6) = 0 <=> IRR = 8% (Round to 0 decimal places.

(c)

NPV of the project is calculated at 6% required rate of return as: -34,700+ (7,500/6%) x (1- (1+6%)^-6) = $2,180.

Thus, new machine should be purchased.