Exercise 12-6 BSU Inc. wants to purchase a new machine for $41,100, excluding $1

Question

Exercise 12-6

BSU Inc. wants to purchase a new machine for $41,100, 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 $2,300, and BSU Inc. expects to sell it for that amount. The new machine would decrease operating costs by $9,800 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.

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(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 10%, determine whether the new machine should be purchased.

Explanation / Answer

Net investment cost = 41100+1500-2300= $40300 a Cash payback period = 40300/9800= 4.1 years b PV factor for Internal rate of return = 40300/9800 = 4.11224 Internal rate of return = 12% c The investment should be accepted.

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