Question

Colby Firestone Corporation is considering the purchase of a new machine to replace an old machine. The new machine will cost $135,000, has an installation cost of $5000, and will have an expected life of five years with a salvage value of $5,000. The new machine will require $2000 additional working capital. The new machine will result in a cost savings of $20,000 a year. Sales are expected to increase $9,000 per year. The old machine was purchased five years ago at a cost of $100,000 and has been depreciated on a (McSlim) straight-line basis with an expected life of ten years and a salvage value of $2000. The old machine can be sold for $50,000 today. The firm’s cost of capital is 9 percent, and its tax rate is 30 percent.

Complete the following information for the Colby Firestone Corporation. Make sure include all the entries and explanations needed to calculate each type of cash flow. (40 points)

Initial Outlay

Operating Cash Flows per year

Total Terminal Cash Flows

1. Payback Period---Compute the payback period. What does the payback period tell us?
2. Net Present Value--- Compute the Net Present Value. What does the Net Present Value tell us?
3. Profitability Index---- Compute the Profitability Index. What does the profitability tell us?
4. Internal Rate of Return--- Compute the Internal Rate of Return. What does the Internal Rate of Return tell us?

Answer 1

Solution:

Formulas: