Ruddy Automobile Repair, Inc., currently has three repair shops in Boston. Wallis Ruddy, the president and chief

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Ruddy Automobile Repair, Inc., currently has three repair shops in Boston. Wallis Ruddy, the president and chief executive officer, is facing a pleasant dilemma: the business has continued to grow rapidly and major shareholders are arguing about different ways to capture more business opportunities. The company requires a 12 percent rate of return for its investment projects and uses the straight-line method of depreciation for all fixed assets.
One group of shareholders wants to open another shop in a newly developed suburban community. This project would require an initial investment of $480,000 to acquire all the necessary equipment, which has a useful life of five years with a salvage value of $160,000. Once the shop begins to operate, another $120,000 of working capital would be required; it would be recovered at the end of the fifth year. The expected net cash inflow from the new shop follows.

Ruddy Automobile Repair, Inc., currently has three repair shops in

A second group of shareholders prefers to invest $400,000 to acquire new computerized diagnostic equipment for the existing shops. The equipment is expected to have a useful life of five years with a salvage value of $80,000. Using this state-of-the-art equipment, mechanics would be able to pinpoint automobile problems more quickly and accurately. Consequently, it would allow the existing shops to increase their service capacity and revenue by $125,000 per year. The company would need to train mechanics to use the equipment, which would cost $45,000 at the beginning of the first year.

Required
Round your computations to two decimal points.
a. Determine the net present value of the two investment alternatives.
b. Calculate the present value index for each alternative.
c. Indicate which investment alternative you would recommend. Explain yourchoice.

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...
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...
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Fundamental Managerial Accounting Concepts

ISBN: 978-0078025655

7th edition

Authors: Thomas Edmonds, Christopher Edmonds, Bor Yi Tsay, Philip Old

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