In: Finance
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 addtional 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%.
Chart below needs filled out for the answer
The Meadville Widgets Company | |||
Replacement Analysis | |||
Old Machine | New Machine | Difference | |
Price | 45,000 | ||
Shipping and Install | 0 | ||
Original Life | 10 | ||
Current Life | 5 | ||
Original Salvage Value | 0 | ||
Current Salvage Value | 27,000 | ||
Book Value | 22,500 | ||
Increase in Raw Materials | 0 | ||
Depreciation | 4,500 | ||
Salaries | 29,000 | ||
Maintenance | 6,000 | ||
Defects | 4,000 | ||
Marginal Tax Rate | 34.00% | ||
Required Return | 15.00% | ||
Cash Flows | Period | Cash Flows | |
Initial Outlay | 0 | 0 | |
Annual After-Tax Savings | 0 | 1 | 0 |
Depreciation Tax Benefit | 0 | 2 | 0 |
Total ATCF | 0 | 3 | 0 |
Terminal Cash Flow | 0 | 4 | 0 |
5 | 0 | ||
Payback Period | |||
Net Present Value (NPV) | |||
Profitability Index (PI) | |||
Internal Rate of Return (IRR) | |||
MIRR |