Chester Industries

Chester Industries manufactures automobile components for the worldwide market. The company has three large production facilities in Virginia, New Jersey, and California, which have been operating for many years. Lance Nicholson, vice president of production, believes it is time to upgrade operations by implementing computer-integrated manufacturing (CIM) at one of the plants.

Lance has asked corporate controller Heidi Rowe to gather information about the costs and benefits of implementing CIM. Rowe has gathered the following data:

Initial equipment cost $6,000,000

Working capital required at start-up $ 600,000

Salvage value of existing equipment $ 75,000

Annual operating cost savings $ 840,000

Salvage value of new equipment at end of its useful life $ 200,000

Working capital released at end of its useful life $ 600,000

Useful life of equipment 10 years

Chester Industries uses a 12% discount rate.

Required

(a) Calculate the net present value of Chester's proposed investment in CIM.

(b) Calculate the internal rate of return on Chester's proposed investment.

(c) Do you recommend that the company proceed with the purchase and implementation of CIM? Why or why not?

(d) Christian Hill, manager of the Virginia plant, has been looking over Rowe's information and believes she has missed some important benefits of implementing CIM. Hill believes that implementing CIM will reduce scrap and rework costs by $150,000 per year. The CIM equipment will take up less floor space in the factory than the old equipment, freeing up 13,000 square feet of space for a planned new research facility. Initial plans called for renting additional space for the new facility each year, at a cost of $20 per square foot. Calculate a revised net present value and internal rate of return using this additional information. Does your recommendation change as a result of this new information? Why or why not?