DCF, accrual accounting rate of return, working capital, evaluation of performance.

The Hammerlink Company has been offered a special-purpose metal-cutting machine for

$132,000. The machine is expected to have a useful life of eight years with a terminal dis¬

posal price of $36,000. Savings in cash operating costs are expected to be $30,000 per year.

However, additional working capital is needed to keep the machine running efficiently and without stoppages. Working capital includes such items as filters, lubricants, bearings,

abrasives, flexible exhaust pipes, and belts. These items must continually be replaced so that an investment of $9,600 must be maintained in them at all times, but this investment is fully recoverable (will be “cashed in”) at the end of the useful life. Hammerlink’s required rate of return is 12%.
Required 1.

a. Compute the net present value.

b. Compute the internal rate ofreturn.
2. Compute the accrual accounting rate ofreturn based on the net initial investment. Assume straight-line amortization.
3. You have the authority to make the purchase decision. Why might you be reluctant to base your decision on the DCF model?
PROBLEMS