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		$81,600		Cost		$38,800
Accumulated depreciation		$41,000		Estimated useful life		8 years
Remaining life		8 years		Salvage value in 8 years		$4,792
Current salvage value		$10,100		Annual cash operating costs		$29,900
Salvage value in 8 years		$0
Annual cash operating costs		$36,000

Depreciation is $10,200 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 $4,792.

1. Determine the cash payback period (Ignore income taxes).

2.Calculate the annual rate of return

3. Calculate the net present value assuming a 17% rate of return (Ignore income taxes)

4. Should the company purchase the new equipment?

Answer 1

1. Cash Pay-back Period:	Old	New
Initial Cost	81600	38800
Amt. that is expenses without actual cash flow :
Annual depreciation claim	10,200
=(38800-4792)/8		4251
Savings in annual Cash Opg. Exp.(36,000-29,900)		6100
Total annual savings	10,200	10,351
Cash Payback Period(in yrs)	(81600-41000)/10200	38800/10,351
	3.982	3.748
2. Annual Rate of Return
Annual savings/Initial Investment	10200/81600	10351/38800
	12.50%	26.678%
3. Net present value assuming a 15% rate of return
Initial Cost	-38800
Salvage of old machine	10,100
PV of Savings in annual Cash Opg. Exp.(36000-29900)*(1-1.17^-8)/0.17	25,664
PV of Salvage (new) (4792/1.17^8)	1364.7
NPV of the Decision	$ 1,671.3
4. As the NPV of the repalcement decision is negative, the Company should not purchase the NEW equipment