Jena Fando owns a fitness center and is thinking of replacing the old treadmill machine with a brand new elliptical 5000. The old treadmill has a historical cost of $30,000 and accumulated depreciation of $27,000, and has a trade-in value of $4,200. It currently costs $600 per month in utilities and another $5,000 a year in maintenance to run the treadmill. Jena feels that the treadmill can be used for another 15 years, after which it would have no salvage value. The elliptical 5000 would reduce the utilities costs by 30% and cut the maintenance cost in half. The elliptical 5000 costs $49,000, has a 15-year life, and an expected disposal value of $4,000 at the end of its useful life. Jena charges customers $5 per hour to use the fitness center. Replacing the fitness machine will not affect the price of service or the number of customers she can serve.

Required:

Jena wants to evaluate the elliptical 5000 project using capital budgeting techniques, but does not know how to begin. To help her, read through the problem and separate the cash flows into four groups: (1) net initial investment cash flows, (2) cash flow savings from operations, (3) cash flows from terminal disposal of investment, and (4) cash flows not relevant to the capital budgeting problem.

Assuming a required rate of return of 7%, and straight-line depreciation over remaining useful life of machines, should Jena buy the Elliptical 5000?