Question

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Within the realm of capital budgeting the majority of projects are not new product lines or major corporate acquisitions. They are replacement projects or projects considered for efficiency gains. Projects taken on for efficiency gains are much less risky than new product lines or large acquisitions. A gain in efficiency or in other words a decreasing of expenses immeadetly increases net income and cash flow. It does not require one addtional item sold. Our case will review an efficiency gain capital budgeting project. Meadville Widgets is considering the purchase of a fully automated widget finishing machine to replace an older but still functioning but more labor intensive model. The machine being replaced was purchased 5 years ago for a price of $45,000.00 at which time it had an expected life of 10 years. This machine is being depreciated by the straight line method with an anticiapated salvage value of $0.00 The current market value of this machine is estimated to be $27,000.00. The current machine requires one operator with an annual cost of $37,500.00 in salary and benifits. The replacement machine has a purchase price of $79,500, a 5 year life, and an expected salvage value of $17,000. The new machine will require a 440 volt three phase electric service and a new concrete pad these installation expenses are $7,500. Meadville Widgets expect the maintence costs to be $5,000 as compared to the current costs of $6,000 and the defects to be $2,000 compared to current defect costs of $4,000. Before considering the purchase of the new machine Meadville Widgets conducted and engineering study to determine if the installation costs would be prohibitive, this study costs $5,000. In order to undertake this project the firm will add $30,000 in debt at 11.5% and the required rate of return is 15%. Meadville Widgets marginal tax rate is 34%.

THE CHART NEEDS TO BE FILLED OUT FOR THE ANSWER

The Meadville Widgets Company
Replacement Analysis
	Old Machine	New Machine	Difference
Price	45,000
Shipping and Install	0
Original Life	10
Current Life	5
Original Salvage Value	0
Current Salvage Value	27,000
Book Value	22,500
Increase in Raw Materials	0
Depreciation	4,500
Salaries	29,000
Maintenance	6,000
Defects	4,000
Marginal Tax Rate	34.00%
Required Return	15.00%
Cash Flows		Period	Cash Flows
Initial Outlay		0	0
Annual After-Tax Savings	0	1	0
Depreciation Tax Benefit	0	2	0
Total ATCF	0	3	0
Terminal Cash Flow	0	4	0
		5	0
Payback Period
Net Present Value (NPV)
Profitability Index (PI)
Internal Rate of Return (IRR)
MIRR

Answer 1