Capital budgeting, computer-integrated manufacturing, sensitivity. Locomotive Engines Inc. is planning to replace the process control system in all of its three production lines. The current system uses mechanical process controls, which have a remaining useful life of 10 years, book value of $10.8 million, a current disposal price of $6 million, and a negli- gible terminal disposal value 10 years from now. The average investment in working capital is $7.2 million. Locomotive Engines Inc. plans to replace all mechanical controls with electronic con- trols that automatically feed a computer-integrated manufacturing (CIM) system at a cost of $54 million. Norbert Grass, the production manager, estimates the following annual cash flow effects of implementing CIM:

a. Cost of maintaining software programs and CIM equipment, $1.8 million

b. Reduction in technicians' fees due to reduced maintenance requirements, $1.2 million

c. Fewer product defects and reduced rework, $5.4 million In addition, Grass estimates the average investment in working capital will decrease to $2.4 million. The estimated disposal price of the CIM equipment is $16.8 million at the end of 10 years. Locomotive uses a required rate of return of 14%.

REQUIRED 1. Compute the net present value of the CIM proposal. On the basis of this criterion, should Locomotive adopt CIM?
2. Grass argues that the higher quality and faster production resulting from CIM will also increase Locomotive’s revenues. He estimates additional cash revenues net of cash-operating costs from CIM of $3.6 million per year. Compute the net present value of the CIM proposal under this assumption.
3. Management is uncertain if the cash flows from additional revenues will occur. Compute the minimum annual cash flow from additional revenues that will cause Locomotive to invest in CIM on the basis of the net present value criterion.
4. Discuss the effects of reducing the investment horizon for CIM to five years, Locomotive’s usual time period for making investment decisions. Assume disposal prices at the end of five years of the CIM line, $24 million; old production line, $4.8 million. Also assume additional cash revenues net of cash operating costs from CIM of $3.6 million per year.LO1