Sprocket Industries is deciding whether to automate one phase of its production process. The manufacturing equipment has a six-year life and will cost $905,000. Projected net cash inflows are as follows:
Year 1..$260,000
Year 2..$254,000
Year 3..$225,000
Year 4..$215,000
Year 5..$205,000
Year 6..$173,000
Requirements
1. Compute this project’s NPV using Sprocket’s 16% hurdle rate. Should Sprocket invest in the equipment?
2. Sprocket could refurbish the equipment at the end of six years for $103,000. The refurbished equipment could be used one more year, providing $75,000 of net cash inflows in year 7. Additionally, the refurbished equipment would have a $54,000 residual value at the end of year 7. Should Sprocket invest in the equipment and refurbishing it after six years? (Hint: In addition to your answer to Requirement 1, discount the additional cash outflow and inflows back to the present value.)