72. (Comprehensive; Appendix 2) The management of Custom Metalworks is evaluating a proposal to purchase a new turning lathe as a replacement for a less efficient piece of similar equipment that would then be sold. The cost of the new lathe including delivery and installation is $700,000. If the equipment is purchased, Custom Metalworks will incur $20,000 of costs in removing the present equipment and revamping service facilities. The present equipment has a book value of $400,000 and a remaining useful life of 10 years. Due to new technical improvements that have made the equipment outmoded, it presently has a resale value of only $160,000.

Management has provided you with the following comparative manufacturing cost tabulation:

Present Equipment New Equipment Annual production in units 400,000 500,000 Cash revenue from each unit $1.20 $1.20 Annual costs:

Labor $120,000 $100,000 Depreciation (10% of asset book value or cost) 40,000 70,000 Other cash operating costs 192,000 80,000 Management believes that if the equipment is not replaced now, the company must wait seven years before replacement is justified. The company uses a 12 percent discount or hurdle rate in evaluating capital projects and expects all capital project investments to recoup their costs within five years.

Both pieces of equipment are expected to have a negligible salvage value at the end of 10 years.

a. Determine the net present value of the new equipment (ignore tax).

b. Determine the internal rate of return on the new equipment (ignore tax).

c. Determine the payback period for the new equipment (ignore tax).

d. Determine the accounting rate of return for the new equipment (ignore tax).

e. Determine whether the company should keep the present equipment or purchase the new lathe.