Background
Allgood Incorporated is considering purchasing a new machine to replace a current machine. The new machine will cost $390,000 and use working capital of $9,000. The current machine can be sold for $6,500. The new machine has a five-year useful life and no salvage value. The hurdle rate is 8 percent. If the new machine is purchased, the operating cash inflows are listed below:
Year 1 – $130,000.
Year 2 – $130,000.
Year 3 – $130,000.
Year 4 – $130,000.
Year 5 – $130,000 (this includes the $9000 release of working capital).
Instructions
For this assignment, address the following:
Calculate the following elements of a capital budget (ignoring income taxes for this step):
The payback period.
Accounting rate of return.
Internal rate of return.
Assuming an income tax rate of 40 percent, calculate the net present value. Remember to calculate the after-tax cash flows from operations and the tax savings from depreciation expense in your analysis.
Should Allgood purchase the machine? Write 3–4 pages justifying your position. Include a discussion of what qualitative factors you would consider.