Question

BSU Inc. wants to purchase a new machine for $41,010, excluding $1,500 of installation costs. The old machine was bought five years ago and had an expected economic life of 10 years without salvage value. This old machine now has a book value of $2,100, and BSU Inc. expects to sell it for that amount. The new machine would decrease operating costs by $9,000 each year of its economic life. The straight-line depreciation method would be used for the new machine, for a six-year period with no salvage value. Click here to view PV table. (a) Determine the cash payback period. (Round cash payback period to 2 decimal places, eg. 10.53.) Cash payback period years (b) Determine the approximate internal rate of return. (Round answer to O decimal places, e.g. 13%. For calculation purposes, use 5 decimal places as displayed in the factor table provided.) Internal rate of return (c) Assuming the company has a required rate of return of 7%, determine whether the new machine should be purchased. The investment be accepted.

Answer 1

a. Cash Payback Period : 4.49 years

Net investment in the new machine = $ 41,010 + $ 1,500 - $ 2,100 = $ 40,410

Cash Payback Period = Net Investment / Cash Savings = $ 40,410 / $ 9,000 = 4.49 years.

b.Internal Rate of Return : 9 %

c. The investment should be accepted.

NPV of the new machine = $ 9,000 x [ { 1 - ( 1/1.07) ⁶ } / 0.07 ] - $ 40,410 = $ 2,488.50

As the NPV is greater than 0, the investment should be accepted.