Edilcan Inc. has been offered an automated special-purpose welder (robot) for $60,000. The machine is expected to have a useful life of eight years with a terminal disposal price of $12,000. Savings in cash operating costs are expected to be $15,000 per year. However, additional working capital is needed to keep the welder running efficiently and without stoppages.
Working capital includes mainly argon gas, wires, and tips. These items must continually be replaced, so an investment of $5,000 must be maintained in them at all times, but this investment is fully recoverable (will be “cashed in”) at the end of the useful life. Edilcan’s requiredrate of return is 14%.
1. a. Compute the net present value.
b. Compute the internal rate of return.
2. Compute the accrual accounting rate of return based on the net initial investment. Assume straight-line amortization.
3. You have the authority to make the purchase decision. Why might you be reluctant to base your decision on the DCF model?