Falcon Manufacturing is a leading manufacturer of airframe components for small aircraft. Heidi Saxton, Falcons operations manager,

Question:

Falcon Manufacturing is a leading manufacturer of airframe components for small aircraft. Heidi Saxton, Falcon’s operations manager, has submitted a request for a new piece of production equipment. Using the new machine, the company will be able to reduce expenses for both maintenance and labor. Data on the project are as follows:

Initial investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $80,000

Useful life . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 years

Salvage value of old machine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,500

Annual cash savings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $15,000

Salvage value of new machine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,000

Maintenance overhaul (year 5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,600

Cost of capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12%

Assume all cash flows occur at the end of each year. (Ignore income tax effects.)

Required:

1. Using the above data, calculate the net present value of the investment. From a strictly quantitative standpoint, should the machine be purchased?

2. Suppose that Heidi receives another analysis that increases the cost of capital estimate to 14% and the new machine’s Salvage value to $17,000. Would the purchase still make sense?

3. Falcon’s CEO, Kevin Davis, is responsible for approving all capital investment projects.

Having spent his entire career dealing with one estimate after another, Kevin has asked you to consider two specific changes:

a. Reduce annual cash inflows by 10%

b. Cut in half the estimated Salvage value of the new equipment

Using the original problem data, calculate the net present value using the CEO’s two changes.

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... Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of...