Question

Simon Lee, the president of Superior Equipment Company, is considering to buy an automated welding machine. He is discussing with his financial controller with the following conversation. “I'm not sure if we should spend $150,000 for that automated welding machine”, said Simon Lee, president of the Superior Equipment Company. “That's a lot of money, and it would cost us $80,000 for software and installment, and another $3,000 every month just to maintain the thing. In addition, the manufacturer admits that it would cost $25,000 more at the end of three years to replace worn-out parts” “I admit it's lots of money,” said Sam Hui, the controller. “But you know the turnover problem we have had with the welding crew. This machine would replace six welders at a cost saving of $108,000 per year. And we would save another $6,500 per year in reduced material waste. When you figure that the automated welder would last for six years, I'm sure the return would be greater than our 12% required rate of return.” "I'm still not convinced,” countered Mr Lee. "We can only get $12,000 scrap value out of our old welding equipment if we sell it now, and in six years the new machine will only be worth $20,000 for parts. But have your people work up the figures and we will talk about them at the executive committee meeting tomorrow.” Required: (a) Calculate the net present value of machine. The present value tables are located on the last page of this examination paper. (8 marks) (b) Recommend the president whether the machine should be purchased. Your recommendations should include both financial and non-financial consideration. (5 marks) (c) The bank has informed Superior Equipment that the interest cost of borrowing will be increased based on the recent assessment of the company's financial position. Discuss the implication on the decision you made in part (b). (2 marks)

Answer 1

Years I Cash I cash Net Cash IPv.f. p.v. of In flow (A) Out flow (B) | In flow (A-B) In flow 12,000 230,000 |(218,000) , 218,000)| 114,500 36,000 78,500 10.893 79,100.5 114,500 36,000 78,500 0.797 62,564.5 114,500 61,000 10.712 | 38,092.0 114,500 36,000 | 78,500 10.636 49,926.0 114,500 36,000 78500 10.567 44,509.5 | 134,500 36,000 | 98500 10.507 49,939.5 $97,132 (B) Machine Should be purchased Reason : Financial : Positive N.P.V. of $ 97,132 Non-Financial: It shifts work from manual to erron are less. (C) for r < 26-19% N.P.V. > 0 m If increase in rate < 261967. then project can be accepted. scanned with CamScanner as a w No - - automated. Therefore chances of