pLEASE Rainbow Products is considering the purchase of a paint-mixing machine to
ID: 2774712 • Letter: P
Question
pLEASE
Rainbow Products is considering the purchase of a paint-mixing machine to reduce labor costs. The savings are expected to result in additional cash flows to Rainbow of $5,000 per year. The machine costs $35,000 and is expected to last for 15 years. Rainbow has determined that the cost of capital for such an investment is 12%. Compute the payback, net present value (NPV), and internal rate of return (1RR) for this machine. Should Rainbow purchase it? Assume that all cash flows (except the initial purchase) occur at the end of the year, and do not consider taxes. For a $500 per year additional expenditure, Rainbow can get a "Good As New" service contract that essentially keeps the machine in new condition forever. Net of the cost of the service contract, the machine would then produce cash flows of $4,500 per year in perpetuity. Should Rainbow Products purchase the machine with the service contract? Instead of the service contract, Rainbow engineers have devised a different option to preserve and actually enhance the capability of the machine over time. By reinvesting 20% of the annual cost savings back into new machine parts, the engineers can increase the cost savings at a 4% annual rate. For example, at the end of year one, 20% of the $5,000 cost savings ($1,000) is reinvested in the machine; the net cash flow is thus $4,000. Next year, the cash flow from cost savings grows by 4% to $5,200 gross, or $4,160 net, of the 20% reinvestment. As long as the 20% reinvestment continues, the cash flows continue to grow at 4% in perpetuity. What should Rainbow Products do?Explanation / Answer
Answer:
Annual Cash Flow = $ 5,000
Initial Cost = $ 35,000
N = 15 Years
i = 12%
A.) Payback, NPV, and IRR of Paint - mixing machine.
1. Payback of the machine is = $ 35,000 / $ 5,000 = 7 Years.
2. NPV of the machinary is $ - 945.67
where, CFO = -35,000
CF1 - CF2 = 5,000 and IRR = 12
3. IRR of the machinary is 11.49
Conclusion : based on both the NPV and the IRR of the machine , Rainbow should reject this purchase.
B). NPV of Paint machine including a service contract
Conclusion: based on NPV , Rainbow should purchase the machine with the service contract.
C.) NPV of Paint mixing and reinvestment of saving in lieu of service contract.
1. NPV = $ 15,000 = -35,000 + 50,000
Conclusion = Based on NPV , Rainbow should reinvest 20% of the cost saving into its machine annually.
1. NPV = $ 2,000 = - 35,500 + 37,500
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.