Question

Farrior Fashions needs to replace a beltloop attacher that currently costs the company $46,000 in annual cash operating costs. This machine is of no use to another company, but it could be sold as scrap for $2,600. Managers have identified a potential replacement machine, Euromat’s Model HD-435. The HD-435 is priced at $52,681 and would cost Farrior Fashions $36,000 in annual cash operating costs. The machine has a useful life of 14 years, and it is not expected to have any salvage value at the end of that time. Click here to view the factor table. (a) Calculate the net present value of purchasing the HD-435, assuming Farrior Fashions uses a 14% discount rate. (For calculation purposes, use 4 decimal places as displayed in the factor table provided and round final answer to 0 decimal place, e.g. 58,971.) Net present value $ (b) Calculate the internal rate of return on the HD-435. Internal rate of return % (c) Calculate the payback period of the HD-435. (Round answer to 4 decimal places, e.g. 15.2515.) Payback period years (d) Calculate the accounting rate of return on the HD-435. (Round answer to 2 decimal places, e.g. 11.25%.) Accounting rate of return % (e) Should Farrior Fashions purchase the HD-435?

Answer 1

NET PRESENT VALUE:
Present value of savings in annual operating cost					84028
($ 14,000 * Annuity factor for year14 i.e.6.002)
Less: Initial Investment:				52681
Less: Salvage value of old machinery				2600	50081
Net Present value					33947
IRR:
NPV at 27%
Present value of savings in annual operating cost					50025.78
($ 14,000 * Annuity factor for year14 i.e.3.573)
Less: Initial Investment:				52681
Less: Salvage value of old machinery				2600	50081
Net Present value					-55.22
Therefore, IRR is 27% approx
Payback period:
Investment			50081
Annual Savings:			14000
Payback period: Average Investment / Annual savings = 50081 /14000 = 3.58 years
Accounting rate of return:
Average Investment (50081/2):250041
Annual savings: $14000
Accounting rate of return: Annual savings/ Average investment *100
		14000 /250041 *100 = 55.91%
Yes, the project shall be accepted