Problem 9-29 Pina Colada Fashions needs to replace a beltloop attacher that curr

Question

Problem 9-29 Pina Colada Fashions needs to replace a beltloop attacher that currently costs the company $46,000 in annual cash operating costs. This machine is of no use to another company, but it could be sold as scrap for $2,550. Managers have identified a potential replacement machine, Euromat's Model HD-435. The HD-435 is priced at $46,942 and would cost Pina Colada Fashions $36,000 in annual cash operating costs. The machine has a useful life of 12 years, and it is not expected to have any salvage value at the end of that time. Click here to view the factor table (a) Calculate the net present value of purchasing the HD-435, assuming Pina Colada Fashions uses a 16% discount rate. (For calculation purposes, use 4 decimal places as displayed in the factor table provided and round final answer to o decimal place, e.g. 58,971.) Net present value (b) Calculate the internal rate of return on the HD-435. Internal rate of return (c) Calculate the payback period of the HD-435. (Round answer to 4 decimal places, e.g. 15.2515.) Payback period years (d) Calculate the accounting rate of return on the HD-435. (Round answer to 2 decimal places, e.g. 11.25%.) Accounting rate of return (e) Should Pina Colada Fashions purchase the HD-435?

Explanation / Answer

(a) Calculation of Net Present Value

Annual Savings on Cash Operating Cost= Cash Operating Cost of Old Machine- Cash Operating Cost of New Machine

Annual Savings= 46,000-36,000 = $10,000

Present Value of Annual Savings= Present Value of Annuity Factor (16%,12 yrs)* Annual Savings

=5.1971*10,000 = $51,971

Initial Investment= Cost of New Machine - Scrap Value of Old Machine

= 46,942- 2,550= $ 44,392

Net Present Value = Present Value of Annual Savings-Initial Investment

= 51,971- 44,392

= $7,579

Thus, NPV = $ 7,579

(b) Calculation of IRR

Let the randomly selcted rates be 16% and 22%

NPV at 16%= 7579 ( as calculated in (a))

NPV at 22%:

Present Value of Savings at 22%= Annual Savings*Present Value Annuity Factor (22%, 12 years)

= 10,000* 4.1274 = $ 41,274

NPV at 20%= Present Value of Savings- Initital Investment

= 41,274-44,392= -3,118 $

Internal Rate of Return =

Lower Rate + NPV at lower rate*(Higher Rate- Lower Rate)/(NPV at lower rate - NPV at higher rate)

= 16+ 7579(22-16)/(7579-(-3118))

=20.2511

Thus, IRR= 20.2511%

(c) Calculation of Payback Period

Payback Period = Cost of Machinery / Annual Cost Saving

=46,942/10,000 = 4.6942 years

(d) Calculation of Accounting Rate of Return

Average Investment = (Initial Cost + Salvage Value)/2

= (46942+0)/2 = 23,471

Average Annual Cost Saving = 10,000

Accounting Rate of Return = (Average Annual Cost Saving/Average Investment)* 100

= (10,000/23,471)*100 = 42.61%

(e) Yes, HD 435 should be purchased because:

Note:

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