Question

Within the realm of capital budgeting the majority of projects are not new product lines or major corporate acquisitions. They are replacement projects or projects considered for efficiency gains. Projects taken on for efficiency gains are much less risky than new product lines or large acquisitions. A gain in efficiency or in other words a decreasing of expenses immeadetly increases net income and cash flow. It does not require one add tional item sold. Our case will review an efficiency gain capital budgeting project Meadville Widgets is considering the purchase of a fully automated widget finishing machine to replace an older but still functioning but more labor intensive model. The machine being replaced was purchased 5 years ago for a price of $45,000.00 at which time it had an expected life of 10 years. This machine is being depreciated by the straight line method with an anticiapated salvage value of $0.00 The current market value of this machine is estimated to be $27,000.00. The current machine requires one operator with an annual cost of $37,500.00 in salary and benifits The replacement machine has a purchase price of $79,500, a 5 year life, and an expected salvage value of $17,000. The new machine will require a 440 volt three phase electric service and a new concrete pad these installation expenses are $7,500. Meadville Widgets expect the maintence costs to be $5,000 as compared to the current costs of $6,000 and the defects to be $2,000 compared to current defect costs of $4,000. Before considering the purchase of the new machine Meadville Widgets conducted and engineering study to determine if the installation costs would be prohibitive, this study costs $5,000. In order to undertake this project the firm will add $30,000 in debt at 11.5 % and the required rate of return is 15 %. Meadville Widgets marginal tax rate is 34 % A C D F F G H K 1 The Meadville Widgets Company 2 Replacement Analysis Old Machine New Machine Difference 45,000 Price 4 5 Shipping and Install 6 Original Life 0 10 Current Life 5 7 8 Original Salvage Value Current Salvage Value 10 Book Value 27,000 9 22,500 11 Increase in Raw Materials 12 Depreciation 4,500 13 Salaries 29,000 14 Maintenance 6,000 15 Defects 4,000 Marginal Tax Rate 34,00% 16 17 Required Return 15.00% 18 Cash Flows Period Cash Flows Initial outlay is after the sale of the old machine 19 Initial Outlay Annual After-Tax Savings Depreciation Tax Benefit 0 0 0 After tax cash flows are adjusted for taxes 20 |The tax benefit of depreciation 0 21 22 Total ATCF 0 0 23 Terminal Cash Flow 0 4 0 5 0 24 25 Payback Period Net Present Value (NPV) Must calculate these values 26 27 Profitability Index (PI) 28 Internal Rate of Return (IRR) 29 MIRR 30 31 32 N

Answer 1

Anscien Given Ihal- Vep laced The mane being wai poxched sycas ago a oice of ,000. 00 foY peded lffe of 10 years inticiPate d saluage valie of o.00 Of 37,s0o co alve 10 Aoval dep¥&ciat?on : (coM Salwase (usoo0- 10 = $u,s00 Terctchine ACcesulated depveciaron 4soots - Book vatuE = 4so00. - 29, voo = 22 ,00 CUStem maise. value $27 /000 Sale procee ots oct of ta :97000-IS30 25,70 O Cashlavs year veA ememi cO- Of machioe ^ Towalation cou- - Sale SPaod eofocexog Study cou of s,000 ?s tax of oc machne SUOS COM. nd hense conderad 279007800 25470

E$61,30 year S cagh p lou! yea Anou aSauing n operatfoo iou = $37,^oo ApOua Savfoa in maiot anomce cosU- - 6000 -So00 =$ \,000 Aoval depreiaon of neas machioe= ( { 19s.o0 7So) - ( 7000): $14,000 frcsemenl-al deprecioton 14000 nova Colhflou (sauirg fo operakon cosi- 4sauing ?n caictomance Depiecaion tar shield. (37500 1000 2000) (1-34 A) 9co0 34% 29/960 nermina cazo Pioci, of nec machne = 417,000 Salvage value NPV Colcestatons NpVAnoual cahfJOu Pu of $1 aunnuty fo S yeONS af IS. t reamioa codh flou pv of 1 fon s ycoyal ^y. - niuns frwey-mecy. (1- 1CH S) 29960 i 7000 4732 7 NpV 432.7 f3 he compomy Should g AS ahea d it verlacermon-