A 1 Chips is a manufacturer of prototype chips based
A- 1 Chips is a manufacturer of prototype chips based in Dublin, Ireland. Next year, in 2014, A- 1 Chips expects to deliver 605 prototype chips at an average price of $ 110,000. A- 1 Chips’ marketing vice president forecasts growth of 55 prototype chips per year through 2020. That is, demand will be 605 in 2014, 660 in 2015,715 in 2016, and so on.
The plant cannot produce more than 575 prototype chips annually. To meet future demand, A- 1 Chips must either modernize the plant or replace it. The old equipment is fully depreciated and can be sold for $ 4,500,000 if the plant is replaced. If the plant is modernized, the costs to modernize it are to be capitalized and depreciated over the useful life of the updated plant. The old equipment is retained as part of the modernize alternative. The following data on the two options are:

A- 1 Chips uses straight- line depreciation, assuming zero terminal disposal value. For simplicity, we assume no change in prices or costs in future years. The investment will be made at the beginning of 2014, and all transac-tions thereafter occur on the last day of the year. A- 1 Chips’ required rate of return is 18%. There is no difference between the modernize and replace alternatives in terms of required working capital. A- 1 Chips has a special waiver on income taxes until 2020.

1. Sketch the cash inflows and outflows of the modernize and replace alternatives over the 2014– 2020 period.
2. Calculate payback period for the modernize and replace alternatives.
3. Calculate net present value of the modernize and replace alternatives.
4. What factors should A- 1 Chips consider in choosing between thealternatives?
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