Question
Hello , I am working on the following problem. A manufacturing company is evaluating two options for new equipment to introduce a new product to
Hello , I am working on the following problem.
A manufacturing company is evaluating two options for new equipment to introduce a new product to its suite of goods. The details for each option are provided below:
Option 1
- $75,000 for equipment with useful life of 7 years and no salvage value.
- Maintenance costs are expected to be $2,500 per year and increase by 3% in Year 6 and remain at that rate.
- Materials in Year 1 are estimated to be $20,000 but remain constant at $10,000 per year for the remaining years.
- Labor is estimated to start at $50,000 in Year 1, increasing by 3% each year after.
Revenues are estimated to be:
Year 1
Year 2 50,000
Year 3 113,000
Year 4 125,000
Year 5 125,000
Year 6 150,000
Year 7 150,000
Option 2
- $50,000 for equipment with useful life of 7 years and a $10,000 salvage value
- Maintenance costs are expected to be $4,500 per year and increase by 3% in Year 6 and remain at that rate.
- Materials in Year 1 are estimated to be $25,000 but remain constant at $20,000 per year for the remaining years.
- Labor is estimated to start at $70,000 in Year 1, increasing by 3% each year after.
Revenues are estimated to be:
Year 1 -
Year 2 75,000
Year 3 100,000
Year 4 125,000
Year 5 155,000
Year 6 200,000
Year 7 150,000
The company's required rate of return and cost of capital is 8%.
Management has turned to its finance and accounting department to perform analyses and make a recommendation on which option to choose. They have requested that the three main capital budgeting calculations be done: NPV, IRR, and Payback Period for each option.
So Far i have worked out (I THINK) the NPV for each option using all the above information.
option 1
PV 8% for years 0-7
(75,000) (67,128) (12,002) 37,670 42,530 36,905 48,778 44,113
NPV= Option 1 Net present value = $55,866
option 2
PV 8% for years 0-7
(50,000) (92,127) (18,518) 982 17,647 35,197 59,374 30,214
NPV = option 2 net present value = (17,231)
I am not sure if these are correct and then how to then go about finding the IRR and payback. I am stuck. can someone lead me in the right direction? thank you.
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