Waterways puts much emphasis on cash flow when it plans for capital investments.
ID: 2477889 • Letter: W
Question
Waterways 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, Waterways then uses different methods to determine the best decisions for making capital outlays.
In 2017 Waterways 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.
$30,425
$43,900
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.)
Using the net present value method for buying new or keeping the old
using the payback method for each choice. (Hint: For the old machine, evaluate the payback of an overhaul.)
Comparing the profitability index for each choice
Calculate the internal rate of return for the new and old blackhoes.
Comparing the internal rate of return for each choice to the required 8% discount rate.
$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 4 IRR For old machine 42.60% For New Machine 9.64%
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