Case 4: Restore Incorporated The information from the meeting related directly t
ID: 2743299 • Letter: C
Question
Case 4: Restore Incorporated
The information from the meeting related directly to the economic effect the machine would have upon the firm. The machine, an Automaster 1, was priced at $60,000 and had a useful life of approximately eight years. Restore’s cost accountant, Barbara Bome, outlined the economic effect of the machine upon the company in Table 1. The Automaster 1 would have a salvage value as follows:
Probability
Estimate
0.30
$5,000
0.20
$7,000
0.50
$6,500
The foregoing data were constructed by Bome and the manufacturer’s representative for the machine. There would also be an increase in working capital at the time of purchase of the new machine. This would amount to $2,000 and was for the purpose of adding extra paint, primer, and other materials that would allow sufficient practice time on the new machine.
The machine to be replaced was purchased two years earlier and was being depreciated to a zero salvage value. Bome reminded Bob Schadler that the present machine had originally cost $24,000. Its 10-year useful life was depreciated using the straight-line method. Bome also reported that the original machine could also be sold for $15,000.
It appeared that smaller body shops, do-it-yourselfers and others, provided a reasonably good secondary market for auto body finishing equipment. The firm’s combined federal, state, and local marginal tax rate was 30 percent. Tables 2 and 3 illustrate the firm’s balance sheet and certain revenue and income projections, respectively.
TABLE 1
Restore Incorporated
Economic Data for Automaster 1
Gross cost (including shipping)
$60,000
Increased (incremental) annual income
$12,000
TABLE 2
Restore Incorporated
Balance Sheet
December 31, 1995
($000s)
Current assets
$ 75
Current liabilities
$ 30
Land
$ 800
Debt (mortgage)
$1,200
Building (net)
$ 800
Equity
$ 400
Equipment (net)
$1,000
Surplus
$1,045
Total fixed assets
$2,600
Total long-term capital
$2,645
Total assets
$2,675
Total liabilities & capital*
$2,675
TABLE 3
Restore Incorporated
Projected Revenue and Income
($000s)
1996
1997
1998
1999
Revenue
$6,000
$6,900
$7,866
$8,445
Earnings after tax
440
464
538
652
QUESTIONS
1. Comment upon the company’s “process” for assessing capital budgeting ideas.
2. Calculate compound growth rates for the company’s projected revenue and earnings.
3. Evaluate the cash flows for the purchase of the Automaster 1 and the replacement of the original machine.
4. Is there an economic justification for the replacement? Please explain your answer.
5. Should the original machine be replaced?
6. What additional economic information would be useful in the replacement decision?
7. Discuss the probability estimate of the new machine’s salvage value. Is it reasonable that the manufacturer would be involved in this process?
8. Consider the company’s size (sales and assets) and its line of business-will unforeseen obsolescence of the Automaster 1 affect the potential replacement of this machine?
Probability
Estimate
0.30
$5,000
0.20
$7,000
0.50
$6,500
Explanation / Answer
1.) Companies mainly look for the return on intial outlay and the benefits they look for the years to come these decision are very sensitive and hence they cannot be replaced or changedd easily. So, mainly companies look for positive NPV and if required return is satisfactory which can be used by using Discount factor which shows the impact of decrease of money value.
2.)
3.)
Take year 0 as 1996 and add for years ahead with 1996.
4.)
Replacement shoul be done as it increases the capacity and productivity as machine gets old it productivity decreases and its maintenance cost in the form of repairs and other cost increases, If you take an asset as car in intial years you don't have to incur any extra cost but in the year's 4-5 and ahead it requires heavy repairs and extra cost.
5.) Yes, as cash flows are Positive and incremental NOPAT and is also high.
6.) Required rate of return and if machine operator is required.
7.) calculated in above part please see it.
8.) yes, it will depend on quantitative figure and how much it's affect on them that much is needed to be seen but unforseen circumstances cannot be accounted for.
1997 1998 1999 1996 CAGR = (invetment value at end / investment value at the end)^1/t Revenue $6,000 $6,900 $7,866 $8,445 35.188% Earnings after tax 440 464 538 652 37.045%Related Questions
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