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Within the realm of capital budgeting the majority of projects are not new product lines or major corporate acquisitions. The vast majority capital budgeting decisions are replacement projects or projects considered for efficiency gains. These projects are taken on for efficiency gains. These projects are much less risky than new product or even an expansion of production since you do not have to sell one more project to increase our net income. A gain in efficiency or in other words a decreasing of expenses immeadetly increases net income and cash flow. It does not require one addtional item sold. Our case will review an efficiency gain capital budgeting project. Hence the only cash flows that are impotant are the differential cash flows. Meadville Widgets is considering the purchase of a fully automated widget finishing machine to replace an older but still functioning but more labor intensive model. The machine being replaced was purchased 5 years ago for a price of $45,000.00 at which time it had an expected life of 10 years. This machine is being depreciated by the straight line method with an anticiapated salvage value of $0.00 The current market value of this machine is estimated to be $27,000.00. The current machine requires one operator with an annual cost of $37,500.00 in salary and benifits. The replacement machine has a purchase price of $79,500, a 5 year life, and an expected salvage value of $17,000. The new machine will require a 440 volt three phase electric service and a new concrete pad these installation expenses are $7,500. Meadville Widgets expect the maintence costs to be $5,000 as compared to the current costs of $6,000 and the defects to be $2,000 compared to current defect costs of $4,000. Before considering the purchase of the new machine Meadville Widgets conducted and engineering study to determine if the installation costs would be prohibitive, this study costs $5,000. In order to undertake this project the firm will add $30,000 in debt at 11.5% and the required rate of return is 15%. Meadville Widgets marginal tax rate is 34% Difference 0 0 The Meadville Widgets Company Replacement Analysis Old Machine New Machine Price 45,000 Shipping and Install 0 Original Life 10 Current Life Original Salvage Value Current Salvage Value 27,000 Book Value 22,500 Increase in Raw Materials Depreciation 4,500 Salaries 37,500 Maintenance 6,000 Defects 4,000 Marginal Tax Rate 34.00% Required Return 15.00% Cash Flows Period Initial Outlay 0 Annual After-Tax Savings Depreciation Tax Benefit Total ATCF Terminal Cash Flow Cash Flows Initial outlay is after the sale of the old machine After tax cash flows are adjusted for taxes The tax benefit of depreciation 0 0 After tax cash flow of sale of new machine Must calculate these values Payback Period Net Present Value (NPV) Profitability Index (PI) Internal Rate of Return (IRR) MIRR