E24-6 BSU Inc. wants to purchase a new machine for $29,300, excluding $1,500 of

ID: 2587156 • Letter: E

Question

E24-6 BSU Inc. wants to purchase a new machine for $29,300, excluding $1,500 of instal.- lation 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 $2,000, and BSU Inc. expects to sell it for that amount. The new machine would decrease operat- ing costs by $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. Instructions (a) Determine the cash payback period. (b) Determine the approximate internal rate of return. (c) Assuming the company has a required rate of return of 10%, state your conclusion on whether the new machine should be purchased. (CGA adapted)

Explanation / Answer

1) Solution: 4.1 years

Explanation: Total net investment = $29,300 + $1,500 – $2,000 = $28,800

Annual net cash flow = $7,000

Cash payback period = $28,800 / $7000 = 4.1 years

2) Solution: 12%

Working:

Particulars

Amount

Years

PV factor

Net annual cash flows

7,000

1-6 years

4.11141

28,780

Capital investment

-28,800

NPV

-20

When the discount rate is 12%, net present value approximates zero

3)Solution: The investment should be accepted

Working: As the internal rate of return of 12% exceeds the required rate of return thus investment should be accepted