BSU Inc. wants to purchase a new machine for $38,800, excluding $1,400 of instal

Question

BSU Inc. wants to purchase a new machine for $38,800, 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 $2,100, and BSU Inc. expects to sell it for that amount. The new machine would decrease operating costs by $9,000 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.

Explanation / Answer

Initial investment = cost of the equipment + installation cost - sale value of the old machine = 38800+1400 - 2100 = $38100

Annual cash inflow from cost savings = $9000

1)

Payback period = Initial investment / annual cash inflow = $38100 / $9000 = 4.2 years

2)

IRR is the discount rate at which the NPV is zero.

NPV at 10% = $9000 x PVIFA(10%, 6) - $38100 = $9000 x 4.354 - $38100 = $39186 - $38100 = $1086

NPV at 11% = $9000 x PVIFA (11%, 6) - $38100 = $9000 x 4.231 - $38100 = $38179 - $38100 = -$21

using interpolation we get:

R = 10% + 1%*((0-1086)/(-21-1086)) = 10.98% = 11% (approx)

Interenal rate of return = 11% (rounded to zero decimal place)

Rate NPV 10% 1086 R 0 11% -21

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