Question

Chapter 19 Homework Vorteck Inc. manufactures snow suits. Vorteck is considering purchasing a new sewing machine at a cost of $2.0 million. Its existing machine was purchased eight years ago at a price of $1.8 million; six months ago, Vorteck spent $55,000 to keep it operational. It is fully depreciated, and can be sold today for $260,000. The new sewing machine would require a one-time $85,000 installation cost. Supervision costs of $200,000 a year can be saved with the new machine. Labor hours, which have a cost of $50 each, would decrease by the following amounts for years 1 to 7:

Year 1 3,800

2 4,000

3 4,220

4 4,520

5 4,680

6 4,700

7 4,720

The new sewing machine will be depreciated as MACRS 5-year property. The salvage value is expected to be $380,000. The new equipment would require maintenance costs of $95,000 at the end of the fifth year for a tune-up. Vorteck’s tax rate is 30%.

1.Calculate the payback period.

2.Use the net present value method to determine whether Vorteck should purchase the new machine to replace the existing machine and state the reason for your conclusion. Vorteck’s required rate of return is 8% (Use NPV function on EXCEL less investment)

3.Calculate the internal rate of return of the investment (Use IRR function on EXCEL)

Answer 1

Note: Depreciation, being a non-cash expense, shall not be considered. Expenses incurred on machine are sunk costs, which are also not relevant in this case.

Working for the above is as under:

In case of any questions on the above workings, please share the same in the comments section.

All the best!