HARTSELL MANUFACTURING HARTSELL MANUFACTURING puts much emphasis on cash flow wh

Question

HARTSELL MANUFACTURING

HARTSELL MANUFACTURING puts much emphasis on cash flow when it plans for capital investments. The company chose its discount rate of 8% based on the rate of return it must pay its owners and creditors. Using that rate, HARTSELL MANUFACTURING then uses different methods to determine the best decisions for making capital outlays.

In 2014 HARTSELL MANUFACTURING is considering buying five new backhoes to replace the backhoes it now has. The new backhoes are faster, cost less to run, provide for more accurate trench digging, have comfort features for the operators, and have 1-year maintenance agreements to go with them. The old backhoes are working just fine, but they do require considerable maintenance. The backhoe operators are very familiar with the old backhoes and would need to learn some new skills to use the new backhoes.

The following information is available to use in deciding whether to purchase the new backhoes.

Old Backhoes

New Backhoes

Purchase cost when new

$90,000

$200,000

Salvage value now

$42,000

Investment in major overhaul needed in next year

$55,000

Salvage value in 8 years

$15,000

$90,000

Remaining life

8 years

8 years

Net cash flow generated each year

$30,425

$43,900

Instructions

(a) Evaluate in the following ways whether to purchase the new equipment or overhaul the old equipment. (Hint: For the old machine, the initial investment is the cost of the overhaul. For the new machine, subtract the salvage value of the old machine to determine the initial cost of the investment.)

(1) Using the net present value method for buying new or keeping the old.

(2) Using the payback method for each choice. (Hint: For the old machine, evaluate the payback of an overhaul.)

(3) Comparing the profitability index for each choice.

(4) Comparing the internal rate of return for each choice to the required 8% discount rate.

(b) Are there any intangible benefits or negatives that would influence this decision?

(c) What decision would you make and why?

Please Post FORMULAS for each equation. Step by step please.

Old Backhoes

New Backhoes

Purchase cost when new

$90,000

$200,000

Salvage value now

$42,000

Investment in major overhaul needed in next year

$55,000

Salvage value in 8 years

$15,000

$90,000

Remaining life

8 years

8 years

Net cash flow generated each year

$30,425

$43,900

Explanation / Answer

Formula for NPV= Present cash inflow*(1+% of return)^-t 1 Old Backhoes Cash Flow NPV Year 0                 -55,000           -55,000 Year 1                   30,425            28,171 Year 2                   30,425            26,085 Year 3                   30,425            24,152 Year 4                   30,425            22,363 year 5                   30,425            20,707 Year 6                   30,425            19,173 Year 7                   30,425            17,753 Year 8                   45,425            24,542          127,946 New Backhoes Cash Flow NPV Year 0               -200,000         -200,000 Year 1                   43,900            40,648 Year 2                   43,900            37,637 Year 3                   43,900            34,849 Year 4                   43,900            32,268 year 5                   43,900            29,878 Year 6                   43,900            27,664 Year 7                   43,900            25,615 Year 8                 133,900            72,342          100,902 formula for payback period = X+Y/Z X is the last period with negetive cummulative cash flow Y is the absolute value of cummulative cash flow at end of period X Z is the total cash flow during the perioed after A 2 Old Backhoes Cash Flow Cummulative Year 0                 -55,000           -55,000 Year 1                   30,425           -24,575 Year 2                   30,425              5,850 Year 3                   30,425            36,275 Year 4                   30,425            66,700 year 5                   30,425            97,125 Year 6                   30,425          127,550 Year 7                   30,425          157,975 Year 8                   45,425          203,400 Pay back period                       1.81 years New Backhoes Cash Flow Cummulative Year 0               -200,000         -200,000 Year 1                   43,900         -156,100 Year 2                   43,900         -112,200 Year 3                   43,900           -68,300 Year 4                   43,900           -24,400 year 5                   43,900            19,500 Year 6                   43,900            63,400 Year 7                   43,900          107,300 Year 8                 133,900          241,200 Pay back period                       4.56 years Profitability Index Old Backhoes Cash Flow Cummulative Year 0                 -55,000           -55,000 Year 1                   30,425           -24,575 Year 2                   30,425              5,850 Year 3                   30,425            36,275 Year 4                   30,425            66,700 year 5                   30,425            97,125 Year 6                   30,425          127,550 Year 7                   30,425          157,975 Year 8                   45,425          203,400 New Backhoes Cash Flow Cummulative Year 0               -200,000         -200,000 Year 1                   43,900         -156,100 Year 2                   43,900         -112,200 Year 3                   43,900           -68,300 Year 4                   43,900           -24,400 year 5                   43,900            19,500 Year 6                   43,900            63,400 Year 7                   43,900          107,300 Year 8                 133,900          241,200 Co. Should go for Existing Backhoes because it's payback period and NPV is better

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