Dublin Chips is a manufacturer of prototype chips based in Dublin, Ireland. Next year, in 2018, Dublin

Question:

Dublin Chips is a manufacturer of prototype chips based in Dublin, Ireland. Next year, in 2018, Dublin Chips expects to deliver 615 prototype chips at an average price of $95,000. Dublin Chips' marketing vice president forecasts growth of 65 prototype chips per year through 2024. That is, demand will be 615 in 2018, 680 in 2019, 745 in 2020, and so on. The plant cannot produce more than 585 prototype chips annually. To meet future demand, Dublin Chips must either modernize the plant or replace it. The old equipment is fully depreciated and can be sold for $4,200,000 if the plant is replaced. If the plant is modernized, the costs to modernize it are to be capitalized and depreciated over the useful life of the updated plant. The old equipment is retained as part of the modernize alternative. The following data on the two options are available:

............................................................Modernize............. Replace

Initial investment in 2018 ...........................$35,300,000 ..........$66,300,000

Terminal disposal value in 2024 .....................$ 7,500,000 .........$16,000,000

Useful life .....................................................7 years ................7 years

Total annual cash operating costs per prototype chip ..$78,500 ...............$66,000

Dublin Chips uses straight-line depreciation, assuming zero terminal disposal value. For simplicity, we assume no change in prices or costs in future years. The investment will be made at the beginning of 2018, and all transactions thereafter occur on the last day of the year. Dublin Chips' required rate of return is 14%. There is no difference between the modernize and replace alternatives in terms of required working capital. Dublin Chips has a special waiver on income taxes until 2024.

Required

1. Sketch the cash inflows and outflows of the modernize and replace alternatives over the 2018-2024 period.

2. Calculate the payback period for the modernize and replace alternatives.

3. Calculate net present value of the modernize and replace alternatives.

4. What factors should Dublin Chips consider in choosing between the alternatives?

Net Present Value
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