Manufacturing, Inc. has a manufacturing machine that needs attention. The compan
ID: 2471898 • Letter: M
Question
Manufacturing, Inc. has a manufacturing machine that needs attention. The company is considering two options. Option 1 is to refurbish the current machine at a cost of $1,200,000. If refurbished, Kilmer expects the machine to last another 8 years and then have no residual value. Option 2 is to replace the machine at a cost of $4,000,000. A new machine would last 10 years and have no residual value. Kilmer expects the following net cash inflows from the two options:
$100,000
$440,000
Kilmer uses straight-line depreciation and requires an annual return of 10%.
Requirement 1. Compute the payback, the ARR, the NPV, and the profitability index of these two options.
Compute the payback for both options. Begin by completing the payback schedule for Option 1 (refurbish).
Net Cash Outflows
Net Cash Inflows
Year
Amount Invested
Annual
Accumulated
0
$1,200,000
1
2
3
4
5
6
7
8
The payback for Option 1 (refurbish current machine) is ____ years. (Round your answer to one decimal place.)
Now complete the payback schedule for Option 2 (purchase).
Net Cash Outflows
Net Cash Inflows
Year
Amount Invested
Annual
Accumulated
0
$4,000,000
1
2
3
4
5
6
7
8
9
10
The payback for Option 2 (purchase new machine) is ____years. (Round your answer to one decimal place.)
Compute the ARR (accounting rate of return) for each of the options.
/
=
ARR
Refurbish
/
=
%
Purchase
/
=
%
Compute the NPV for each of the options. Begin with Option 1 (refurbish). (Enter the factors to three decimal places. X.XXX. Use parentheses or a minus sign for a negative net present value.)
Net Cash
PV Factor
Present
Years
Inflow
(i = 10%)
Value
Present value of each year's inflow:
1
(n = 1)
2
(n = 2)
3
(n = 3)
4
(n = 4)
5
(n = 5)
6
(n = 6)
7
(n = 7)
8
(n = 8)
Total PV of cash inflows
0
Initial investment
Net present value of the project
Now compute the NPV for Option 2 (purchase). (Enter the factors to three decimal places. X.XXX. Use parentheses or a minus sign for a negative net present value.)
Net Cash
PV Factor
Present
Years
Inflow
(i = 10%)
Value
Present value of each year's inflow:
1
(n = 1)
2
(n = 2)
3
(n = 3)
4
(n = 4)
5
(n = 5)
6
(n = 6)
7
(n = 7)
8
(n = 8)
9
(n = 9)
10
(n = 10)
Total PV of cash inflows
0
Initial investment
Net present value of the project
Finally, compute the profitability index for each option. (Round to two decimal places X.XX.)
/
=
Profitability index
Refurbish
/
=
Purchase
/
=
Requirement 2.
Which option should Kilmer choose? Why? Review your answers in Requirement 1.
Kilmer should choose___________because this option has a __________ payback period, and ARR that is ________ the other option, a _________ NPV, and its profitability index is _________.
Years Refurbish Current Machine Purchase New Machine 1$100,000
$2,250,000 2$440,000
$650,000 3 $340,000 $550,00 4 $240,000 $450,000 5 $140,000 $350,000 6 $140,000 $350,000 7 $140,000 $350,000 8 $140,000 $350,000 9 $350,000 10 $350,000 Total $1,680,000 $6,000,000Explanation / Answer
Option 1:
Payback period :
$ 140,000
Payback period = 4 + (1,200,000 - 1,120,000) / (1,260,000 - 1,120,000) = 4.57 years
Accounting rate of return = Total cash flows - Total depreciation / Net Investment x 100 = $ 1,680,000 - $ 1,200,000 / 1,200,000 = 40%
NPV = 100,000 x 0.909 + 440,000 x 0.826 + 340,000 x 0.751 + 240,000 x 0.683 x 140,000 x 2.165 - 1,200,000 = $ (90,900 + 363,440 + 255,340+ 163,920 + 303,100) - 1,200,000 = $ (23,300)
Profitability Index = 1,176,700 / 1,200,000 = 0.98
Option 2:
Payback period:
Payback period = 4 + 4,000,000 - 3,900,000 / 4,250,000 - 3,900,000 = 4.28 years
Accounting rate of return = Total cash flows - Total depreciation / Net investment x 100 = 6,000,000 - 4,000,000 / 4000,000 = 50%
NPV = 2,250,000 x 0.909 + 650,000 x 0.826 + 550,000 x 0.751 + 450,000 x 0.683 + 350,000 x 2.975 - 4,000,000 = 2,045,250 + 536,900 + 413,050 + 307,350 + 1,041,250 - 4,000,000 = $ 343,800
Profitability Index = $ 4,343,800 / $ 4,000,000 = 1.09
Kilmer should choose Option 2 because this option has a shorter payback period, and ARR that is higher than the other option, a higher NPV, and its profitability index is greater.
Year Cash inflows Cumulative cash flows 1 $ 100,000 $ 100,000 2 $ 440,000 $ 540,000 3 $ 340,000 $ 880,000 4 $ 240,000 $ 1,120,000 5 $ 140,000 $ 1,260,000 6 $ 140,000 7$ 140,000
8 $ 140,000Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.