Capital budgeting, computer-integrated manufacturing, sensitivity. The Dynamo Corporation is planning to replace one of its production fines, which has a remaining useful life often years, book value of $10.8 million, a current disposal price of $6 million, and a neg¬

ligible terminal disposal value ten years from now. The average investment in working capital is $7.2 million.

Dynamo plans to replace the production line with a computer-integrated manufactur¬

ing (CIM) system at a cost of $54 million. Jeremy Burns, the production manager, estimates the following annual cash flow effects ofimplementing CIM:

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

b. Reduction in lease payments due to reduced floor space requirements, $1.2 million

c. Fewer product defects and reduced rework, $5.4 million In addition, Burns 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 often years. Dynamo uses a required rate ofreturn of 14%.

Required 1. Compute the net present value of the CIM proposal. On the basis of this criterion, should Dynamo adopt CIM?

2. Burns argues that the higher quality and faster production resulting from CIM will also increase Dynamo’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 pro¬

posal 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 Dynamo to invest in CIM on the basis ofthe net present value criterion.

4. Discuss the effects of reducing the investment horizon for CIM to five years, Dynamo’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.