Question

Vaughn Inc. wants to purchase a new machine for $45,800, excluding $1,500 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 $2,400, and Vaughn 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.

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(a)

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

Cash payback period

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

%

(c)

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

The investment

should/should not

be accepted.

Answer 1

Initial investment = $45,800+1,500-2,400 = $44,900

a. Cash pay back period = Initial investment / Annual cost savings

Cash pay back period = $44,900 / $10,000 = 4.49 years

b. Internal rate of return:

Annual value = 4.49 years

At 4.49 for 6 years = 9%

Hence IRR = 9%

c.

Net present value = Present value of cash inflow - Initial investment

Present value of cash flow = $10,000 * 4.76654 (PVAF@7%, 6years) = $47,665

Net present value = $47,665 - $44,900 = $2,765

The investment should be accepted as NPV is positive.

answered by: anonymous