Expert Chips is a manufacturer of prototype chips based in Dublin, Ireland. Next year, in 2014, Expert Chips expects to deliver 562 prototype chips at an average price of $95,000. Expert Chips' marketing vice president forecasts growth of 50 prototype chips per year through 2020. Thatis, demand will be 562 in

2014, 612 in 2015, 662 in 2016, and so on. The plant cannot produce more than 542 prototype chips annually. To meet future demand, Expert Chips must either modernize the plant or replace it. The old equipment is fully depreciated and can be sold for $4,200,000 if the plant is replaced. If the plant ismodernized, the costs to modernize it are to be capitalized and depreciated over the useful life of the updated plant. The old equipment is retained as part of the modernize alternative. The following data on the two options are:

	Modernize		Replace
Initial investment in 2014	$34,500,000		$66,100,000
Terminal disposal value in 2020	$6,200,000		$17,300,000
Useful life	7 years		7 years
Total annual cash operating cost per prototype chip	$76,500		$66,000

Expert Chips uses straight-line depreciation, assuming zero terminal disposal value. For simplicity, we assume no change in prices or costs in future years. The investment will be made at the beginning of

2014, and all transactions thereafter occur on the last day of the year. Expert Chips' required rate of return is 6%. There is no difference between the modernize and replace alternatives in terms of required working capital. Expert Chips has a special waiver on income taxes until 2020.

REQUIRED

Sketch the cash inflows and outflows of the modernize and replace alternatives over the 2014-2020 period.
Calculate payback period for the modernize and replace alternatives.
Calculate net present value of the modernize and replace alternatives.
What factors should Expert Chips consider in choosing between the alternatives?