Everest has also found that, after only two years of using a machine for a semi-automatic process, a more advanced model has arrived on the market. This advanced model will not only produce the current volume of the company's product more efficiently, but allow increased output of the product. The existing machine had cost $320,000 and was being depreciated over a ten-year period, at the end of which it would be scrapped. The market value of this machine is currently $150,000 and there is a prospective purchaser interested in acquiring it.
The advanced model now available costs $1,235,000 fully Stalled. Because of its more complex mechanism, the advanced model is expected to have a useful life of only eight years. A scrap value of $205,000 is considered reasonable after 8 years.
A comparison of the existing and advanced model now available shows the following:
|
|
Existing Machine
|
Advanced
Machine
|
|
Capacity
|
200,000 units
|
230,000 units
|
|
Selling price per unit
|
$9.50
|
$9.50
|
|
Production costs per unit
|
|
|
|
Labour
|
$1.20
|
$0.80
|
|
Materials
|
$4.80
|
$4.60
|
|
Fixed overhead
|
$2.50
|
$1.60
|
The sales are expected to be 200,000 units every year for the next 8 years. Because of the advanced nature of material, working capital investment would decrease by $100,000 at the current time. The production costs are based on a production of 200,000 units a year. The tax rate for the company is 20%.
The required rate of return is estimated as 15%. Evaluate the proposal to purchase advanced machine by:
(a) Calculating the payback period if advanced machine is purchased.
(b) Calculating the net present value if advanced machine is purchased.
(c) Calculating the internal rate of return if advanced machine is purchased.
(d) Explaining whether the advanced machine should be purchased. What other considerations arc relevant for your decision?