Fresno Manufacturing Company specializes in the production of precision tools. Management is in the process of selecting a new drill press. The press under consideration will cost $92,000 plus necessary installation charges of $5,000. Experience indicates that the press will last for five years and should have a residual value at the end of that period of about $10,000. Expected annual cash revenues from the press should average $45,000, and related cash operating costs should be around $20,000. Management has decided on a minimum desired before-tax rate of return of 10 percent.
Present value multipliers:
|
6percent |
10percent |
12percent |
| present value of $1 at the end of five years |
.747 |
.621 |
.567 |
| present value of $1 received in each of the next five years |
4.212 |
3.791 |
3.605 |
a. Using before-tax information and the net present value method to evaluate this capital investment, determine whether the company should purchase the drill press. Show all calculations to support your answer.
b. Calculate the profitability index. Should your reject or accept the project based on the profitability?
c.If management has decided on a minimum desired before-tax rate of return of 12 percent, should the drill press be purchased? Show all computations to support your answer.