Question

(This is a continuation of the Waterways Problem from Chapters 1 through 11.)

WCP12 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 2017 Waterways is considering buying five new backhoes to replace the backhoes it now has. The new backhoes are faster, cost less to run, provide for more accurate trench digging, have comfort features for the operators, and have 1-year maintenance agreements to go with them. The old backhoes are working just fine, but they do require considerable maintenance. The backhoe operators are very familiar with the old backhoes and would need to learn some new skills to use the new backhoes.

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

	Old Backhoes	New Backhoes
Purchase cost when new	$90,000	$200,000
Salvage value now?	$42,000
Investment in major overhaul needed in next year	$55,000
Salvage value in 8 years?	$15,000	$90,000
Remaining life?	8 years	8 years
Net cash flow generated each year	$30,425	$43,900

PLEASE PROVIDE CLEAR STEPS, THANK YOU SO MUCH!
(a) Evaluate in the following ways whether to purchase the new equipment or overhaul the old equipment. (Hint: For the old machine, the initial investment is the cost of the overhaul. For the new machine, subtract the salvage value of the old machine to determine the initial cost of the investment.)

(1) Using the net present value method for buying new or keeping the old.

(2) Using the payback method for each choice. (Hint: For the old machine, evaluate the payback of an

(b) Are there any intangible benefits or negatives that would influence this decision? ?

Answer 1

1. NPV = Present Value of Cash Inflows - Present Value of Cash Outflows

Old

= 30425*PVAF(8%,8yrs) + 15000*PVF(8%,8yrs) - 55000

= 30425*5.7466 + 15000*0.5403 - 55000

= 127944.805

New

= 43950*5.7466 + 90000*0.5403 - 200000

101190.07

Both the projects are profitable, But it is more profitable to keep the old one.

(2) Payback period :

OLD

=55000/30425 = 1.81 years

New

=200000/43900 = 4.55 years

Again, Old is better.

(b) Since the operators are familiar with the old backhoes and will need to learn new skills to operate new ones, the management might have to incur additional cost on the training plus the revenue loss for that time period. Also, the operators might not be willing to shift to the new system.