Question
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
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
- $65,000 for equipment with useful life of 7 years and no salvage value.
- Maintenance costs are expected to be $2,700 per year and increase by 3% in Year 6 and remain at that rate.
- Materials in Year 1 are estimated to be $15,000 but remain constant at $10,000 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 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 |
---|---|---|---|---|---|---|
- | 75,000 | 100,000 | 125,000 | 150,000 | 150,000 | 150,000 |
Option 2
- $85,000 for equipment with useful life of 7 years and a $13,000 salvage value
- Maintenance costs are expected to be $3,500 per year and increase by 3% in Year 6 and remain at that rate.
- Materials in Year 1 are estimated to be $20,000 but remain constant at $15,000 per year for the remaining years.
- Labor is estimated to start at $60,000 in Year 1, increasing by 3% each year after.
Revenues are estimated to be:
Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 |
---|---|---|---|---|---|---|
- | 80,000 | 95,000 | 130,000 | 140,000 | 150,000 | 160,000 |
The company’s required rate of return 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 four main capital budgeting calculations be done: NPV, IRR, Payback Period, and ARR for each option.
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