Alderman Industries is deciding whether to automate one pase of its production p

Question

Alderman Industries is deciding whether to automate one pase of its production process. The manufacturing equipment has a six-year life and will cost $915,000.

Projected net cash inflows are as follows:

Year 1 - $264,000

Year 2 - $253,000

Year 3 - $224,000

Year 4 - $213,000

Year 5 - $204,000

Year 6 - $177,000

Compute this project's NPV using Alderman Industries' 16% hurdle rate, should the company invest in the equipment? Why or why not?

Alderman's Industries could refurbish the equipment at the end of six years, for $104,000. The refurbished equipment could be used for one more year, providing $76,000 of net cash inflows in year 7. Additionally, the refurbished equipment would have a $55,000 residual value at the end of year 7. Should the company invest in the equipment and refurbish it after six years? Why or why not? (Hint: Discount the additional cash outflows and inflows back to the present value.)

Explanation / Answer

Statemnet showing Cash flows Particulars Time PVf@16% Amount PV Cash Outflows                                 -                          1.00      (915,000.00)       (915,000.00) PV of Cash outflows       (915,000.00) Cash inflows                          1.00                   0.8621        264,000.00         227,586.21 Cash inflows                          2.00                   0.7432        253,000.00         188,020.21 Cash inflows                          3.00                   0.6407        224,000.00         143,507.32 Cash inflows                          4.00                   0.5523        213,000.00         117,638.00 Cash inflows                          5.00                   0.4761        204,000.00            97,127.06 Cash inflows                          6.00                   0.4104        177,000.00            72,648.28 PV of Cash Inflows         846,527.08 NPV         (68,472.92) No since NPV is negative If the company has purchased the Equipment and   Statemnet showing Cash flows Particulars Time PVf@16% Amount PV Cash Outflows                            6.00                        0.41      (104,000.00)         (42,685.99) PV of Cash outflows         (42,685.99) Cash inflows                          7.00                   0.3538           76,000.00            26,891.04 Cash inflows                          7.00                   0.3538           55,000.00            19,460.62 PV of Cash Inflows            46,351.67 NPV              3,665.67 Yes since NPV is positive if company has purchased the equipment then it should go for refurbish But overall its not benefitable to invest as combine NPV is negative = -68,472.92 + 3,665.67 = -64,807.25

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