Case 4: Restore Incorporated

The information from the meeting related directly to the economic effect the machine would have upon the firm. The machine, an Automaster 1, was priced at $60,000 and had a useful life of approximately eight years. Restores cost accountant, Barbara Bome, outlined the economic effect of the machine upon the company in Table 1. The Automaster 1 would have a salvage value as follows:

Probability	Estimate
0.30	$5,000
0.20	$7,000
0.50	$6,500

The foregoing data were constructed by Bome and the manufacturers representative for the machine. There would also be an increase in working capital at the time of purchase of the new machine. This would amount to $2,000 and was for the purpose of adding extra paint, primer, and other materials that would allow sufficient practice time on the new machine.

The machine to be replaced was purchased two years earlier and was being depreciated to a zero salvage value. Bome reminded Bob Schadler that the present machine had originally cost $24,000. Its 10-year useful life was depreciated using the straight-line method. Bome also reported that the original machine could also be sold for $15,000.

It appeared that smaller body shops, do-it-yourselfers and others, provided a reasonably good secondary market for auto body finishing equipment. The firms combined federal, state, and local marginal tax rate was 30 percent. Tables 2 and 3 illustrate the firms balance sheet and certain revenue and income projections, respectively.

TABLE 1 Restore Incorporated Economic Data for Automaster 1
Gross cost (including shipping)	$60,000
Increased (incremental) annual income	$12,000

TABLE 2 Restore Incorporated Balance Sheet December 31, 1995 ($000s)
Current assets	$ 75	Current liabilities	$ 30
Land	$ 800	Debt (mortgage)	$1,200
Building (net)	$ 800	Equity	$ 400
Equipment (net)	$1,000	Surplus	$1,045
Total fixed assets	$2,600	Total long-term capital	$2,645
Total assets	$2,675	Total liabilities & capital*	$2,675

TABLE 3 Restore Incorporated Projected Revenue and Income ($000s)
	1996	1997	1998	1999
Revenue	$6,000	$6,900	$7,866	$8,445
Earnings after tax	440	464	538	652

QUESTIONS

1. Comment upon the companys process for assessing capital budgeting ideas.

2. Calculate compound growth rates for the companys projected revenue and earnings.

3. Evaluate the cash flows for the purchase of the Automaster 1 and the replacement of the original machine.

4. Is there an economic justification for the replacement? Please explain your answer.

5. Should the original machine be replaced?

6. What additional economic information would be useful in the replacement decision?

7. Discuss the probability estimate of the new machines salvage value. Is it reasonable that the manufacturer would be involved in this process?

8. Consider the companys size (sales and assets) and its line of business-will unforeseen obsolescence of the Automaster 1 affect the potential replacement of this machine?