Question

The Casper Ice Cream Company is an ice cream manufacturer in Richmond, Utah famous for making Fat Boy Ice Cream Sandwiches. The owner, Mr. Casper, the grandson of the founder, is considering replacing an existing ice cream maker and batch freezer with a new maker which has a greater output capacity and operates with less labor. His only alternative is to overhaul his ice cream maker and batch freezer which have a current net book value of $6,000 and three years of remaining depreciable life (straight line). The equipment would cost $10,000 to overhaul but this would increase its useful life for 10 years which is also the life of the new machinery. Mr. Casper’s accountant tells him the new net book value of the overhauled equipment could be depreciated straight line over four years. The old machinery has zero salvage value currently.

The new maker and freezer would cost $50,000 including installation. It would be fully depreciated over 10 years and would have $3,000 salvage at the end of that period. Because of automatic features, the new equipment would allow labor saving of $9,000 per year.

Even though the new equipment has increase capacity, Mr. Casper does not feel any extra product could be sold until year five. At that time, he estimates that additional sales would result in additional net cash revenues before tax of $5,000 per year for the remaining life of the machine. By the end of year four, however, working capital would have to be increased by $3,000 to support the higher sales. This increase in working capital will be recovered at the end of the project, which will last for 10 years.   

Casper Company is currently in the 30% tax bracket. Mr. Casper demands a rate of return of 16%.   

Complete a NPV and IRR analysis on the project.

Answer 1

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Amount in $,