Ayayai Fashions needs to replace a beltloop attacher that currently costs the co
ID: 2550872 • Letter: A
Question
Ayayai Fashions needs to replace a beltloop attacher that currently costs the company $41,000 in annual cash operating costs. This machine is of no use to another company, but it could be sold as scrap for $2,230. Managers have identified a potential replacement machine, Euromat’s Model HD-435.
The HD-435 is priced at $54,201 and would cost Ayayai Fashions $31,000 in annual cash operating costs. The machine has a useful life of 12 years, and it is not expected to have any salvage value at the end of that time.
Click here to view the factor table.
(a) Calculate the net present value of purchasing the HD-435, assuming Ayayai Fashions uses a 14% discount rate. (For calculation purposes, use 4 decimal places as displayed in the factor table provided and round final answer to 0 decimal place, e.g. 58,971.)
(b) Calculate the internal rate of return on the HD-435.
(c) Calculate the payback period of the HD-435. (Round answer to 4 decimal places, e.g. 15.2515.)
(d) Calculate the accounting rate of return on the HD-435. (Round answer to 2 decimal places, e.g. 11.25%.)
(e) Should Ayayai Fashions purchase the HD-435?
Explanation / Answer
(a)
Initial cost of machine to company = Price of machine - gain from selling the old machine
= $ 54,201 - $ 2,230 = $ 51,971
Annual operating cost savings
= Annual operating cost of old machine - Annual operating cost of new machine
= $ 41,000 - $ 31,000 = $ 10,000
NPV = Initial cost + annual cash flow x PVIAF (r, n)
= - $ 51,971 + $ 10,000 x PVIAF (14 %, 12)
= - $ 51,971 + $ 10,000 x 5.6603
= - $ 51,971 + $ 56,603 = $ 4,632
(b)
Year
Cash flow
0
$ (51,971)
1
$ 10,000
2
$ 10,000
3
$ 10,000
4
$ 10,000
5
$ 10,000
6
$ 10,000
7
$ 10,000
8
$ 10,000
9
$ 10,000
10
$ 10,000
11
$ 10,000
12
$ 10,000
IRR
16.00%
(c)
Computation of Payback period:
Year
Cash flow
‘Cum Cash Flow
0
$ (51,971)
$ (51,971)
1
$ 10,000
$ (41,971)
2
$ 10,000
$ (31,971)
3
$ 10,000
$ (21,971)
4
$ 10,000
$ (11,971)
5
$ 10,000
$ (1,971)
6
$ 10,000
$ 8,029
7
$ 10,000
$ 18,029
8
$ 10,000
$ 28,029
9
$ 10,000
$ 38,029
10
$ 10,000
$ 48,029
11
$ 10,000
$ 58,029
12
$ 10,000
$ 68,029
Payback Period = A +B/C
Where,
A= Last period with a negative cumulative cash flow = 5
B = Absolute value of a cumulative cash flow at the end of the period A = $ 1,971
C = Total cash flow during the period after A = $ 10,000
Payback Period = 5 +$ (1,971)/$10,000
= 5 + $ 1,971/ $ 10,000
= 5 + 0.1971 = 5.1971 years
(d)
Accounting rate of return = Average accounting profit/Initial investment
= $ 10,000/ $ 51,971 = 0.192415 or 19.24 %
(e)
Yes, Ayayai Fashions should purchase the HD-435 based on positive NPV and higher IRR than discount rate of Ayayai.
Year
Cash flow
0
$ (51,971)
1
$ 10,000
2
$ 10,000
3
$ 10,000
4
$ 10,000
5
$ 10,000
6
$ 10,000
7
$ 10,000
8
$ 10,000
9
$ 10,000
10
$ 10,000
11
$ 10,000
12
$ 10,000
IRR
16.00%
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