BSU Inc. wants to purchase a new machine for dollar 29,600, excluding dollar 1,1

Question

BSU Inc. wants to purchase a new machine for dollar 29,600, excluding dollar 1,100 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 dollar 1,900, and BSU Inc. expects to sell it for that amount. The new machine would decrease operating costs by dollar 7,000 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. (For calculation purposes, use 5 decimal places as displayed in the factor table provided.) Determine the cash payback period. (Round cash payback period to 1 decimal place, e.g. 10.5.) Cash payback period years Determine the approximate internal rate of return. (round answer to 0 decimal places. e.g. 10.) Internal rate of return percent Assuming the company has a required rate of return of 11 percent, determine whether the new machine should be purchased. The investment be accepted.

Explanation / Answer

Answer 1:

Total current outflow = Cost of new machine + installment costs - salvage value of old machine

= 29,600 + 1,100 - 1,900 = $28,800

Cash payback period(when cash inflows per year are equal) = Total current outflow / Yearly cash inflow

= 28,800 / 7,000 = 4.1 years or 4 years 1 month (approx)

Answer 2:

Internal rate of return = 11.98% or 12%

Answers 3:

The investment should be accepted as new machine has internal rate of return of 12% which is higher than required rate of return of 11%.

Description Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Saving in operating costs                     7,000               7,000               7,000               7,000               7,000               7,000 P.V. factor @ 11.98%                   0.8931            0.7975            0.7123            0.6361            0.5681            0.5073 Present Value                     6,251               5,583               4,986               4,453               3,976               3,551 Total present value of savings                   28,800 Total present value of outflows(29600+1100-1900)                   28,800

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