Exercise 12-6 BSU Inc. wants to purchase a new machine for $25,900, excluding $1

Question

Exercise 12-6

BSU Inc. wants to purchase a new machine for $25,900, excluding $1,200 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 $1,700, and BSU Inc. expects to sell it for that amount. The new machine would decrease operating costs by $6,000 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.

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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.

Cash payback period

years Internal rate of return

% The investment

be accepted.

Explanation / Answer

a.

Annual savings = 6000 will be annual cash inflow

cash payback period= net investment/annual cash flow= 25400/6000= 4.23 years

b. IRR is the rate at which NPV = 0, at around 11% NPV of the project is 0.

c. Since required rate of return 10% is less than project IRR of 11% the project should be accepted.

Initial investment: Item Amount Equipment                    27,100 Less: old machine salvage                      1,700 Net investment                    25,400

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