Ludmilla Quagg owns a fitness centre and is thinking of replacing the old Fit-O-Matic machine with a brand new Flab-Buster 3000. The old Fit-O-Matic has a historical cost of $50,000 andaccumulated amortization of $46,000, but has a trade-in value of $5,000. It currently costs $1,200 per month in utilities and another $10,000 a year in maintenance to run the Fit-O-Matic. Ludmilla feels that the Fit-O-Matic can be used for another ten years, after which it would have no salvage value. The Flab-Buster 3000 would reduce the utilities costs by 30% and cut the maintenance cost in half. The Flab-Buster 3000 costs $98,000, has a ten-year life, and an expected disposal value of $10,000 at the end of its useful life. Ludmilla charges customers $10 per hour to use the fitness centre. Replacing the fitness machine will not affect the price of service or the number of customers she can serve. Ludmilla also looked at replacing the Fit-O-Matic with a Walk-N-Pull Series 3, which costs $78,000. However, she prefers the Flab-Buster 3000.
REQUIRED
1. Ludmilla wants to evaluate the Flab-Buster 3000 project using capital budgeting techniques, but does not know how to begin. To help her, read through the problem and separate the cash flows into four groups:
(1) net initial investment cash flows,
(2) cash flow savings from operations,
(3) cash flows from terminal disposal of investment, and
(4) cash flows not rele- vant to the capital budgeting problem.
2. Assuming a required rate of return of 8%, and straight-line amortization over remaining useful life of machines, should Ludmilla buy the Flab-Buster 3000?