Case Study:

A manufacturing company is evaluating two options for new equipment to introduce a new product to its suite of goods. The details for each option are provided below:

Option 1

• $75,000 for equipment with useful life of 7 years and no salvage value.
• Maintenance costs are expected to be $2,500 per year and increase by 3% in Year 6 and each year thereafter.
• Materials in Year 1 are estimated to be $20,000 but remain constant at $10,000 per year for the remaining years.
• Labor is estimated to start at $50,000 in Year 1, increasing by 3% each year after.

Revenues are estimated to be:

Year 1 -

Year 2- 50,000

Year 3- 113,000

Year 4- 125,000

Year 5- 125,000

Year 6- 150,000

Year 7-150,000

Option 2

• $50,000 for equipment with useful life of 7 years and a $10,000 salvage value
• Maintenance costs are expected to be $4,500 per year and increase by 3% in Year 6 and each year thereafter.
• Materials in Year 1 are estimated to be $25,000 but remain constant at $20,000 per year for the remaining years.
• Labor is estimated to start at $70,000 in Year 1, increasing by 3% each year after.

Revenues are estimated to be:

Year 1 -

Year 2- 75,000

Year 3- 100,000

Year 4- 125,000

Year 5- 155,000

Year 6- 200,000

Year 7-150,000

The company's required rate of returnand cost of capital is 8%.

Management has turned to its finance and accounting department to perform analyses and make a recommendation on which option to choose. They have requested that the three main capital budgeting calculations be done: NPV, IRR, and Payback Period for each option.