KLW Corporation is considering the purchase of a new piece of equipment. Relevan

Question

KLW Corporation is considering the purchase of a new piece of equipment. Relevant information concerning the equipment follows: Cost of the equipment $180,000 Annual cost savings from new equipment $37,500 Life of the new equipment 12 years Required: a. Compute the payback period for the equipment. If the company requires a payback period of four years or less, would the equipment be purchased? b. Compute the simple rate of return on the equipment. Use straightline depreciation based on the equipment’s useful life.   c. Calculate the Net Present Value of the project. Required rate of return is 14%. d. Provide the internal rate of return for the project. e. Based upon the four methods. Make a recommendation regarding the purchase of the equipment.  

Explanation / Answer

a. Payback period = initial otflow / annual inflow

=$180000 / $37500

=4.8 years

No,  If the company requires a payback period of four years or less, equipment should not be purchased becasue its recovery of cost period is 4.8 years.

C . Net present value = preset value of cash inflow - present value of cash outflow

present value of cash inlfow = 37500 * PVAF(14%, 12 years)

= $37500 * 5.660

=$212250

Net present value = $212250 - $180000

= $32250

D Internal rate of return

     make an approximation of the IRR(internal rate of return) on the basis of cash flows data, A rough appromximation may be made with reference to the payback period . the payback period = 4.8 years

Now, search for a value nearest to the 4.8 in the 12th year row of the PVAFtable . the closest figures are given in the rate 18% ( 4.793 , approximate 4.8 value)

Therefore, the IRR = 18%

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