Question

A company is considering replacement of manufacturing equipment with computer controlled equipment, at a cost of $500,000, replacing equipment with a scrap value of $50,000. This will reduce defect costs by $150,000 a year. At the end of 7 years, the equipment will be replaced and will have a scrap value of $100,000. The interest charges for financing the purchase will be $25,000 a year. The new system will be housed in a building that is currently unused, with an overhead value of $10,000 a year. Utility costs will be unchanged. Machine operators will require training of $1000 each for 4 workers. These workers are scheduled for a raise of $3000 each. Because the new equipment technology is well-established for its intended use, the risk premium for the project is considered to be 2 percentage points less than the company’s WACC of 8%.

1.1 List the investment facts for the project:

*NOTE: List all of the financial details associated with the
project and designate which should be included (and which ignored)
in calculating the project’s cash flows and its cost of
capital.*

Life of the project: 7 years

Interest rate for the project: 6% (8-2) *(cost of
capital to the firm adjusted for project risk)*

PVIF for the project: 0.666

PVIFA for the project: 5.582

A. Initial investment: *(include all cash flows - positive
and negative - that occur at the beginning of the project)*

B. Future cash flows: *(negative and positive)*

C. Lump sum: *(one time)*

D. Annuity: *(repeated annually)*

E. Costs that you will ignore: *(sunk cost or
otherwise)*

1.2. A. Using the relevant net cash flows and cost of capital
from A above, calculate the NPV for the project. *(use the NPV
formula and the PV tables)*

*Please Answer:*

*1.1* *A.*

*1.1 B.*

*1.1 C.*

*1.1 D*

*1.1 E.*

*1.2 A.*

Answer #1

1.1A: The intitial investment is

Machine expenses: $500,000; Scrap sale: $50,000

Hence initial invsetment = 500000-50000

= $450,000

1.1B: The Cash flows are as shown below

1.1C: Lumpsum amount can be calculated by calculating the present values of all the cashflows of total shown above, WACC is 8%. So Calculating Present value of all above cash flows

The Lumpsum amount come $ 123,779.7

1.1D: The annuties can be counted are defect costs, interest cost, Overhead charge

= 150,000+25000+10000

= $185,000

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