Lundholm Corp. is considering the purchase of a robotic machine that would repla
ID: 2381861 • Letter: L
Question
Lundholm Corp. is considering the purchase of a robotic machine that would replace a manual labor production task. This project would require an upfront cash commitment of $2,000,000 to purchase and install the equipment. The equipment would have an expected life of 5 years and generate annual labor cost savings of $600,000. Assume the equipment would be depreciated over 5 years with no salvage value.
Prepare a time line for this project that shows both the cash flow and accounting earnings effects for the project's 5-year life. Ignore taxes. Enter cash outflows and subtractive amounts as negative numbers.
Cash flows
Period: 0 1 2 3 4 5
Accounting earnings
Period: 1 2 3 4 5
Expense savings
Depreciation
Explanation / Answer
Cash flows
Accounting earnings
Depreciation = $2,000,000/5 years = $400,000 per year
I didn't see any information in this problem that told how much cash flow the new machine would generate per year, so I had to assume that it was $0. You can see that $600,000 per year is saved on labor while $400,000 of depreciation is taken each year. This leaves a net increase in income of $200,000 per year(holding all other things constant), which is good in that regard.
However, without knowing how much cash flow the machine will generate, one cannot conclude that this machine is a good investment for the company. In fact, the machine cost $2,000,000 upfront and only yielded a total increase to net income of $1,000,000 by the end of the 5 year life. That would show that the machine proved to be unprofitable overall to the tune of $1,000,000 ($1,000,000 increase in net income minus $2,000,000 cost). Again, the problem information seems to be incomplete, but this is what we can conclude based off of the given facts.
Anyway, I hope that helps you out. Please rate.
Period 0 1 2 3 4 5 Total(2,000,000) 0 0 0 0 0 (2,000,000)
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