A body lotion company can upgrade the quality of one of its products by purchasing new equipment

Question:

A body lotion company can upgrade the quality of one of its products by purchasing new equipment at a cost of $155,000. The new equipment would replace old equipment that has a current market value of $23,000 equalling its book value. The new equipment has an expected life of 12 years. Its salvage value is estimated at $30,000. By upgrading the quality of this product, the company would be able to increase the sale price. As a result, the operating income before tax will increase by $20,000 per year for the first three years, and by an additional $5,000 per year during the last nine years. The company’s tax rate is 40% and its cost of capital after tax is 14%. The CCA rate for the new equipment is 20%.

Required:

1. Compute the NPV for the investment, and state whether the company should proceed with the investment.

2. Determine the IRR for this investment. Use trial and error.

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...

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