BSU Inc. wants to purchase a new machine for $44,100, excluding $1,500 of instal

Question

BSU Inc. wants to purchase a new machine for $44,100, excluding $1,500 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 $2,400, and BSU Inc. expects to sell it for that amount. The new machine would decrease operating costs by $10,500 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.

(a)

Determine the cash payback period. (Round cash payback period to 1 decimal place, e.g. 10.5.)

(b)

Determine the approximate internal rate of return. (Round answer to 0 decimal places, e.g. 10. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

(c)

Assuming the company has a required rate of return of 11%, determine whether the new machine should be purchased.

Explanation / Answer

a)

Initial Investment = Machine cost + Installation cost - Sale value of old machine

Initial Investment = 44100 + 1500 - 2400

Initial Investment = 43200

Annual Cash Saving = 10500

cash payback period = Initial Investment /Annual Cash Saving

cash payback period = 43200/10500

cash payback period = 4.11 Years

b)

Internal rate of return is the rate of return where NPV is equal to zero i.e

PV of Cash Inflow = PV of cash outflow

10500*PVIFA(rate,6) = 43200

PVIFA(rate,6) =43200/10500

PVIFA(rate,6) = 4.11429

Using PV table where we found in 6 year at 12%

IRR = 12%

c)

The new machine should be purchased, since IRR is greater than required rate of return

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