Ann & Andy Machine Company bought a cutting machine, Model KC12, on March 5, 2010, for $5,000

Question:

Ann & Andy Machine Company bought a cutting machine, Model KC12, on March 5, 2010, for $5,000 cash. The estimated salvage value and estimated life were $600 and 11 years, respectively. On March 5, 2011, Ann, the company CEO, learned that she could purchase a different cutting machine, Model AC1, for $8,000 cash. The new machine would save the company an estimated $750 per year in cash operating costs compared to KC12. AC1 has an estimated salvage value of $400 and an estimated life of 10 years. The company could get $3,000 for KC12 on March 5, 2011. The company uses the straight-line method for depreciation (non-MACRS-based) and a 12 percent discount rate.

Required

1. Compute, for AC1, the:

a. Payback period of the proposed investment, under the assumption that the cash inflows occur evenly throughout the year.

b. Book rate of return (ARR) using the average investment; assume that any loss on the disposal of the existing machine is spread out evenly over the 10-year life of the new machine.

c. Net present value (NPV).

d. Internal rate of return (IRR).

e. Modified internal rate of return (MIRR) also, explain the difference between a project’s IRR and its MIRR.

2. Should the firm purchase AC1? Why?

3. What is the minimum (or maximum) savings that AC1 must have without altering your decision in requirement 2?

Net Present Value
What is NPV? The net present value is an important tool for capital budgeting decision to assess that an investment in a project is worthwhile or not? The net present value of a project is calculated before taking up the investment decision at... Internal Rate of Return
Internal Rate of Return of IRR is a capital budgeting tool that is used to assess the viability of an investment opportunity. IRR is the true rate of return that a project is capable of generating. It is a metric that tells you about the investment... Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important... Payback Period
Payback period method is a traditional method/ approach of capital budgeting. It is the simple and widely used quantitative method of Investment evaluation. Payback period is typically used to evaluate projects or investments before undergoing them,...