Madden Limited is the largest Canadian producer of dairy products. The company needs to replace its equipment.

Question:

Madden Limited is the largest Canadian producer of dairy products. The company needs to replace its equipment. The current equipment was purchased 18 years ago at a cost of $2 million, and it was depreciated over a 20-year period using the straight-line method, assuming no expected salvage value. Management believes that, currently, the equipment could be sold for $150,000.

The new equipment would cost $2,850,000 and have an expected residual value of $525,000 at the end of its estimated life of 10 years. With the new equipment, the current operating costs of $1.5 million would decrease by 30% in year 1, remain at that level for year 2 and year 3, decrease by another 10% in year 4, and remain at that level for the remaining life of the asset. With the new equipment, the company would have to hire another operator at an annual cost of $30,000. The company's cost of capital is 12%.

Instructions

(a) Assuming that the company decides to buy the new equipment now, calculate the initial investment.

(b) Calculate the total net savings in operating costs over the expected life of the new equipment. Show your calculations.

(d) If the maximum acceptable payback period for the company is eight years, should the company replace the equipment now? Explain your rationale and show your calculations.

Net Present Value
What is NPV? The net present value is an important tool for capital budgeting decision to assess that an investment in a project is worthwhile or not? The net present value of a project is calculated before taking up the investment decision at... Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important... Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Payback Period
Payback period method is a traditional method/ approach of capital budgeting. It is the simple and widely used quantitative method of Investment evaluation. Payback period is typically used to evaluate projects or investments before undergoing them,...