Question

Magna Inc. is considering modernizing its production facility by investing in new equipment and selling the old equipment. The following information has been collected on this investment.

Old Equipment				New Equipment
Cost		$80,480		Cost		$38,480
Accumulated depreciation		$40,700		Estimated useful life		8 years
Remaining life		8 years		Salvage value in 8 years		$4,800
Current salvage value		$10,400		Annual cash operating costs		$29,400
Salvage value in 8 years		$0
Annual cash operating costs		$35,300

Depreciation is $10,060 per year for the old equipment. The straight-line depreciation method would be used for the new equipment over an eight-year period with salvage value $4,800.

1. Determine the cash payback period (Ignore income taxes). (Round answer to 3 decimal places, e.g. 15.275.)
2. Calculate the annual rate of return. (Round answer to 2 decimal places, e.g. 15.25%.)
3. Calculate the net present value assuming a 17% rate of return (Ignore income taxes). (If the net present value is negative, use either a negative sign preceding the number e.g. -45 or parentheses e.g. (45). For calculation purposes, use 5 decimal places as displayed in the factor table provided, e.g. 1.25124 and final answer to 0 decimal places, e.g. 5,275.)
4. Should the company purchase the new equipment?

Answer 1

1		$
	Cost of new equipment	38,480
	Less: Salvage value of old equipment	(10,400)
	Cash outflow	28,080
	Annual cash operating cost- Old equipment	35,300
	Annual cash operating cost- New equipment	(29,400)
	Cost benefit	5,900
	Cash payback period = $ 28,080 / $ 5,900 = 5 years
2	Annual rate of return = Annual benefit / Initial investment cost
	= $ 5,900 / $ 28,080 = 21%
3
Year	Cash flows	Amount	PV factor at 17%	Discounted amount
0	Net cash outflow of new equipment	(28,080.00)	1.00	(28,080.00)
1	Annual cost benefit	5,900.00	0.85	5,042.74
2	Annual cost benefit	5,900.00	0.73	4,310.03
3	Annual cost benefit	5,900.00	0.62	3,683.79
4	Annual cost benefit	5,900.00	0.53	3,148.54
5	Annual cost benefit	5,900.00	0.46	2,691.06
6	Annual cost benefit	5,900.00	0.39	2,300.05
7	Annual cost benefit	5,900.00	0.33	1,965.85
8	Annual cost benefit	5,900.00	0.28	1,680.22
8	Salvage value of new equipment	4,800.00	0.28	1,366.96
	Net Present Value ( NPV )			(1,890.79)
4	NPV is negative. Therefore, company should not purchase the new equipment.