Problem Goal incongruence and ROl. Comfy Corporation manufactures furniture in s

Question

Problem Goal incongruence and ROl. Comfy Corporation manufactures furniture in several divisions including the patio furniture division. The manager of the patio furniture division plans to retire in two years. The manager receives a bonus based on the division's ROI, which is currently 7% One of the machines that the patio furniture division uses to manufacture the turmiture is rather> old, and the manager must decide whether to replace it. The new machine would cost $35,000 and would last 10 years. It would have no salvage value. The old machine is fully depreciated and has no trade-in value. Comfy uses straight-line depreciation for all assets. The new machine being new and more efficient, would save the company $5,000 per year in cash operating costs The only difference between cash flow and net income is depreciation. The internal rate of return of the project is approximately 7%. Comfy Corporation's weighted-average cost of capital is 5% Comfy is not subject to any income taxes 1. Should Comfy Corporation replace the machine? Why or why not? 2. Assume that "investment" is defined as average net long-term assets (that is, afte ing the year. Compute the projects ROl for each of its first five years. If the patio f interested in maximizing his bonus, would he replace the machine before he retire 3. What can Comfy do to entice the manager to replace the machine before retiring?

Explanation / Answer

1.It would be better off if the machine is replaced.Its cost of capital is 5% and the IRR of the investment is 7%, indicating that this is a positive net present value project.

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