Question

The management of Devine Instrument Company is considering the purchase of a new drilling machine, model RoboDril 1010K. According to the specifications and testing results, RoboDril will substantially increase productivity over AccuDril X10, the machine Devine is currently using.

The AccuDril was acquired 8 years ago for $110,000 and is being depreciated using the straight-line method over a 10-year expected life and an estimated salvage value of $30,000. The engineering department expects the AccuDril to keep going for another 3 years after a major overhaul at the end of its expected useful life. The estimated cost for the overhaul is $90,000. The overhauled machine will be depreciated using straight-line depreciation with no salvage value. The overhaul will improve the machine’s operating efficiency approximately 10% for each of years 3, 4, and 5. No other operating conditions will be affected by the overhaul.

RoboDril 1010K is selling for $220,000. Installing, testing, rearranging, and training will cost another $20,000. The manufacturer is willing to take the AccuDril as a trade-in for $30,000. The RoboDril will be depreciated using the straight-line method. New technology most likely will make RoboDril obsolete to the firm in 5 years.

Variable operating cost for either machine is the same: $10 per machine hour (cash-based). Other pertinent data follow:

	AccuDril X10				RoboDril 1010K
Units of output (per year)		10,000				10,000
Machine hours		8,000				4,000
Selling price per unit	$	100			$	100
Variable manufacturing cost—cash-based	$	25			$	25
(not including machine hours)
Other annual expenses (tooling and supervising)	$	90,000			$	60,000
Disposal value—today	$	35,000
Disposal value—in 5 years	$	0			$	40,000

Devine Instrument Company’s weighted-average cost of capital (WACC) is 8%, and it is in the 40% tax bracket. Use the PV factors (Appendix C, Table 1) for calculating the NPV of each decision alternative.

Answer 1

Initial investment Profit loss on diposal accudrill Incremental savings Savings in machine cost[reduced hours) Savins in other annual exp Puchase price robodrill Insatll test train Post tax salvage accudrill 400010 90000-60000 Add less 0 220000 20000 36400 203600 Current book value 110000-110000-30000)*810 Sale value loss on sale tax savings 16000*4 Post tax salvage value(30000+6400) 46000 30000 16000 6400 40000 30000 70000 36400 1 70000 2 70000 90000 3 70000 4 70000 5 70000 1 Annual Savings 2 Overhaul exp saved 3 Incremental Depreciation: Notes 1 Since the decision of buying new machine involves trade in, we assume that Devine intrument has gone for trade in. 2 The effect of increse in efficiency countnt be qualified from given data. NPV=299390-203600=95790 4 New machine dep=240000-400005 Old machine Dep=110000-30000/10 Incremental Depreciation(New -old) 6 incrementtal profits before tax(1+2-3) incrementtal profits after tax(746) Add increm depreciation 10 Add salvage of Robodrill 11 Annual Cash Flow[7+9+10) 12 PVAF 8% 13 Present value of CF 40000 40000 40000 40000 40000 8000 8000 32000 32000 40000 40000 40000 38000 128000 30000 30000 30000 22800 76800 18000 18000 18000 32000 32000 40000 40000 40000 40000 54800 108800 58000 58000 98000 0.925926 0.857339 0.793832 0.73503 0.680583 50740.74 93278.46 46042.27 42631.73 66697.15 299390.3591