Waterways puts much emphasis on cash flow when it plans for capital investments. The company chose its discount rate of 8% based on the rate of return it must pay its owners and creditors. Using that rate, Waterways then uses different methods to determine the best decisions for making capital outlays.

In 2016 Waterways is considering buying five new backhoes to re- place the backhoes it now has with its installation and training division.

The new backhoes are faster, cost less to run, provide for more accurate trench digging, have comfort features for the operators, and have associated one-year maintenance agreements. The old backhoes are working well, but they do require considerable maintenance. The operators are very familiar with the old backhoes and would need to learn some new skills to use the new equipment.

The following information is available to use in deciding whether to purchase the new backhoes.

Instructions
(a) Using the following methods, evaluate whether to purchase the new equipment or overhaul the old equipment. Ignore income taxes in your analysis.
1. Use the net present value method for buying new or keeping the old.
2. Use machine, evaluate the payback of an overhaul.)
3. Compare the profitability index for each choice.
4. Compare the internal rate of return for each choice to the required 8% discount rate.
(b) Are there any intangible benefits or negatives that would influence this decision?
(c) What decision would you make and why?

Old Backhoes $90,000 S42,000 $55,000 New Backhoes Purchase cost when new Salvage value now Investment in major overhaul needed in next year Salvage value in 8 years Remaining life Net cash flow generated each year $200,000 None None $ 50,000 8 years $ 41,000 None 8 years $25,250