Jane Fando owns a fitness center and is thinking of replacing the old Ab- O- Matic machine with a brand new Flab- Blaster 5000. The old Ab- O- Matic has a historical cost of $ 25,200 and accumulated depreciation of $ 23,000, but has a trade- in value of $ 2,700. It currently costs $ 600 per month in utilities and another $ 5,000 a year in maintenance to run the Ab- O- Matic. Jane feels that the Ab- O- Matic can be used for another 11 years, after which it would have no salvage value. The Flab- Blaster 5000 would reduce the utilities costs by 30% and cut the maintenance cost in half. The Flab- Blaster 5000 costs $ 49,000, has an 11- year life, and an expected disposal value of $ 5,000 at the end of its useful life. Jane charges customers $ 5 per hour to use the fitness center. Replacing the fitness machine will not affect the price of service or the number of customers she can serve.

Required

1. Jane wants to evaluate the Flab- Blaster 5000 project using capital budgeting techniques, but does not know how to begin. To help her, read through the problem and separate the cash flows into four groups:

(1) Net initial investment cash flows,

(2) Cash flow savings from operations,

(3) Cash flows from terminal disposal of investment, and

(4) Cash flows not relevant to the capital budgeting problem.

2. Assuming a tax rate of 40%, a required rate of return of 8%, and straight- line depreciation over remaining useful life of machines, should Jane buy the Flab- Blaster 5000?