Camus Blalack, process engineer, knew that the acceptance of a new process desig

Question

Camus Blalack, process engineer, knew that the acceptance of a new process design would depend on its economic feasibility. The new process desgin required new equipment and an infusion of working capital. The equipment would cost $300,000 and its cash operating expenses would total $60,000 per year. The equipment would last for seven years but would need a major overhaul costing $30,000 at the end of the fifth year. At the end of seven years, the equipment would sold for $24,000. An increase in working capital totaling $30,000 would also be needed at the beginning. This would be recovered at the end of the seven years.

On the benefit side, Camus estimated that the new process would save $135,000 per year in environmental costs (fines and cleanup costs avoided). The cost of capital is 10%. Ignore tax effects.

Question: Is it beneficial to implement the new design process?

Explanation / Answer

Yes, it is beneficial to implement the new design process, as it would yield a positive NPV of $ 44,097

Period Cash outflows($) Net saving in operating expenses($) Equipment overhaul expense($) Residual value($) Working capital recovered($) PV factor at 10% PV of cash flows($) 0 (300,000) 1 (300,000) 0 (30,000) 1 (30,000) 1 (135,000-60,000)=75,000 0.909 68,175 2 75,000 0.826 61,950 3 75,000 0.751 56,325 4 75,000 0.683 51,225 5 75,000 (30,000) 0.621 27,945 6 75,000 0.564 42,300 7 75,000 24,000 30,000 0.513 66,177 NPV 44,097

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