Capital Budgeting Pete\'s Precision Presses is considering purchasing a new pres

Question

Capital Budgeting Pete's Precision Presses is considering purchasing a new press for $200,000. The press will save the company $60,000 per year in production costs for 7 years. After 7 years the press will have a value of $50,000. Depreciation is calculated over 7 years using straight-line. 1. Calculate the Payback Period Should the company buy the press if its minimum ARR is 20%? 3. Calculate the Net Present Value (NPV) of the press using 15% interest. Should the company buy the press using NPV? Capital Budgeting Pete's Precision Presses is considering purchasing a new press for $200,000. The press will save the company $60,000 per year in production costs for 7 years. After 7 years the press will have a value of $50,000. Depreciation is calculated over 7 years using straight-line. 1. Calculate the Payback Period Should the company buy the press if its minimum ARR is 20%? 3. Calculate the Net Present Value (NPV) of the press using 15% interest. Should the company buy the press using NPV?

Explanation / Answer

Working Note Statement Showing Calculation of NPV and Payback Period Year Detail Cash Flow PVF @ 15% Present Value Cummulative Cash Flow PVF@35% Present Value @35% 0 Cost of Purchasing Press -$200,000                 1.000 -$200,000 -$200,000 1 -$200,000 1 Annual Cash Flow $70,000            0.86957 $60,870 -$139,130 0.740741 $51,852 2 Annual Cash Flow $70,000            0.75614 $52,930 -$86,200 0.548697 $38,409 3 Annual Cash Flow $70,000            0.65752 $46,026 -$40,174 0.406442 $28,451 4 Annual Cash Flow $70,000            0.57175 $40,023 -$152 0.301068 $21,075 5 Annual Cash Flow $70,000            0.49718 $34,802 $34,651 0.223014 $15,611 6 Annual Cash Flow $70,000            0.43233 $30,263 $64,914 0.165195 $11,564 7 Annual Cash Flow $70,000            0.37594 $26,316 $91,229 0.122367 $8,566 7 Residual Value $50,000            0.37600 $18,800 $110,029 0.122367 $6,118 Net present Value $110,029 -$18,355 Pay back Period 4 Year ( Approx) NPV is Positive , Hence Press Should be Purchased 1 Pacy Back period 4 Year (Approx) 2            IRR=     Lower discount rate            + Lowere rate NPV                   * (Higher Rate- lower Rate) Lowere rate NPV- Higher rate NPV            IRR=                               15%            + 110029 (35%-15%) $110029-(-$18355) IRR= 32.14% ARR is 20% ARR is less then IRR hence, Compamny should not buy the project 3 NPV @ 15% $110,029 NPV is Positive hence Company Can buy the Press

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