Problem: B Inc. wants to replace its R & D equipment with new hi tech equipment. The existing equipment was purchased 5 years ago, on January 1, 2009, at a cost $150,000. At that time, the equipment had an expected life of 10 years with an expected salvage value of zero. This equipment has since then been depreciated on a straight line basis. As at January 1, 2014, its current market value is $75,000.
The new hi tech equipment can be purchased for $200,000 including installation as at January 1, 2014. Over this new equipment's expected 10 year useful life, savings in raw material usage and overhead costs will result in reductions in R & D costs of $21,000 annually for years 1 to 6; $38,800 for years 7, 8 and 9; a terminal year saving of $30,000 in year 10.
It is estimated that the new equipment can be sold for $50,000 at the end of its useful life on January 1, 2024. Since the new equipment's' cash flows are relatively certain, the project's cost of capital is set at 10%.
The firm normally requires a maximum payback period of 5 years for such projects.
Assignment Requirement:
Question 1: Calculate the initial investment amount.
Question 2: Calculate the project's cash payback period.
Question 3: Calculate the project's net present value.
Question 4: Make a recommendation as to whether the company should or should not replace the old R & D equipment with the new hi tech equipment. Provide evidence to justify your recommendation considering quantitative and qualitative factors.
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