Exercise 12-6 BSU Inc. wants to purchase a new machine for $35,500, excluding $1

Question

Exercise 12-6 BSU Inc. wants to purchase a new machine for $35,500, 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 $2,200, and BSU Inc. expects to sell it for that amount. The new machine would decrease operating costs by $7,500 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. 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 O decimal places, e.g. 10. For calculation purposes, use 5 decimal places as displayed in the factor table provided.) Internal rate of return Assuming the company has a required rate of return of 6%, determine whether the new machine should be purchased The investmen e accepted should should not

Explanation / Answer

(a) Clculation of Payback period:

Payback Period = Net Cash flow at year 0 / Decrease in operating cost per year
= ($35000 + $1400 - $2200) / $7500
= $34,200 / $7500
= 4.56 year

(b) Calculation of IRR

At IRR, NPV = 0

At 8.5% discount rate, NPV is almost 0 . Hence IRR of the project is 8.5%.

(c). The new machine should be purchased as IRR of the project is greater than required rate of return.

Year Cash Flow Discount Factor @8.5% Present Value 0 ($34,200) 1 ($34,200) 1-6 $7500 4.55359 $34,151 NPV ($49)

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