Question

Capital Budgeting Project
Business Case:
The Managerial Accounting Department at your company has been engaged by the Production Department for
assistance in evaluating a purchase decision. The equipment the production department is currently utilizing is outdated
and has become costly to maintain. New machines would also provide increased efficiencies leading to increased sales.
Due to this, the department is considering replacing all equipment with new machines.
Data:
- Cost of Current Machines: $800,000
- Cost of New Machines: $1,250,000
- Annual Maintenance on Current Machines: $125,000
- Annual Maintenance on New Machines: $54,000
- Salvage Value of Current Machines: $325,000
- Immediate employee training cost on new machines: $15,000
- Working Capital needed for new machines: $50,000
- Would be needed once machines are purchased and working capital released after 5 years
- Increased sales opportunity provided by new machines: $200,000 first year and growing at 5% per year
after
- Company’s Required Rate of Return: 10%
- Contribution margin: 47%
- Depreciation and income taxes should be ignored.
Final Deliverable
Given the financial information listed above, provide the following 2 files:
- An Excel worksheet showing the annual cash flows by line-item and in total for the keep vs. purchase decision, for
8 years.
• Calculate the NPV in excel
• Calculate the IRR in excel
• Should the Department purchase new equipment or maintain the current equipment?
- Report: Prepare a report** to management summarizing the following:
• Overview of the issue being considered (who has engaged you, why?)
• Overview of the main cost/decision drivers (what is most important to this decision)
• NPV/IRR – Provide and describe these numbers (including what they mean) and based on those include and
support your recommendation to the Production Department.

This is the template we are given in excel. (please explain answers)

Year	0	1	2	3	4	5	6	7	8
Total Cash In/(Out)flow
Discount Rate factor (XX%)
Present Values
Net Present Value

Answer 1

Keep machine
Description	0	1	2	3	4	5	6	7	8
Salvage value of current machine	-325000
Annual maintenance on current machine		-125000	-125000	-125000	-125000	-125000	-125000	-125000	-125000
Opportunity cost of losing contribution		-94000	-98700	-103635	-108817	-114258	-119970	-125969	-132267
Total cash(out) flow for keeping the machine	-325000	-219000	-223700	-228635	-233817	-239258	-244970	-250969	-257267
Discount factor@10%	1	0.90909091	0.826446281	0.751314801	0.683013455	0.6209213	0.56447393	0.513158118	0.46650738
Present value	-325000	-199091	-184876	-171777	-159700	-148560	-138279	-128787	-120017
Total net Present value of cash Outflow	-1576087.3
IRR
Purchase machine
Description	0	1	2	3	4	5	6	7	8
Cost of new machine	-1250000
Salvage value of current machine	325000
Immidiate employee training cost	-15000
Working capital (employed)/Released	-50000					50000
Annual maintenance on current machine		-54000	-54000	-54000	-54000	-54000	-54000	-54000	-54000
Contribution margin from sales opprotunity		94000	98700	103635	108817	114258	119970	125969	132267
Total cash(out) flow for keeping the machine	-990000	40000	44700	49635	54817	110258	65970	71969	78267
Discount factor@10%	1	0.90909091	0.826446281	0.751314801	0.683013455	0.6209213	0.56447393	0.513158118	0.46650738
Present value	-990000	36364	36942	37292	37441	68461	37239	36931	36512
Total net Present value of cash Outflow	-662818
Note : Since It is negetive PV , we can not find IRR
Yes, Department should purchase a new machine as net present value of cash outflow of purchasing machine is less than net present value of cash outflow of keeping the machine
Report to production department
To
Production department
Dear Sirs,
AS engaged by you for deciding the best course of action for capital budgeting.
Net present value of the outcome of the decision in both cases implies the present value of future outflow discounted at appropriate rate i.e 10% in our case
Based on the calculations, we have found Net present value of the both decision as follows
Keep machine		-1576087.3
Purchase machine		-662818
And since net present value of cash outflow of purchasing the machine is less than net present value of cash outflow of keeping the machine, we advise you
to purchase the machine
Thank you
Yours truly