Question

Exercise 25-06

BSU Inc. wants to purchase a new machine for $45,600, excluding $1,200 of installation costs. The old machine was bought five years ago and had an expected economic life of 10 years without salvage value. This old machine now has a book value of $1,900, and BSU Inc. expects to sell it for that amount. The new machine would decrease operating costs by $10,000 each year of its economic life. The straight-line depreciation method would be used for the new machine, for a six-year period with no salvage value.

Click here to view the factor table.

(a)

Determine the cash payback period. (Round cash payback period to 2 decimal places, e.g. 10.53.)

Cash payback period

enter the Cash payback period in years rounded to 2 decimal places

years

(b)

Determine the approximate internal rate of return. (Round answer to 0 decimal places, e.g. 13%. For calculation purposes, use 5 decimal places as displayed in the factor table provided.)

Internal rate of return

enter the Internal rate of return in percentages rounded to 0 decimal places %

(c)

Assuming the company has a required rate of return of 7%, determine whether the new machine should be purchased.

The investment select an option

shouldshould not

be accepted.

Answer 1

BSU inc.

initial investment = 45600 + 1200 = $ 46800

Remaining life = 5 years

Sale proceeds from old machine = 1900

Savings = $ 10000

Useful life = 6 years

SLM method

Salvage value = 0

Cost of capital = 7 %

Part a

Payaback period = Initial investment / annual net cash inflow

( 46800 - 1900 ) / 10000 =4.49 years

Part b

IRR is that rate of return where PV of all cash inflows = PV of all cash outflows

10000 * PVIFA ( I, 6 ) = 46800 - 1900

10000 * PVIFA ( I,6 ) = 44900

Looking at PVIFA table, we find that at 9 % , 6th period : factor is 4.49

So IRR = 9 %

Part c

Let us calculate NPV for this :-

10000 * PVIFA ( 7 % , 6 ) - 44900

10000 * 4.7665 - 44900

$ 2765 ( NPV is positive )

Investment should be accepted.