Problem 2 (40 points) Cool Air Generations, Inc. manufactures commercial grade air conditioning units. The company as an opportunity to modify the current assembly-line by adding a new piece of equipment that will improve operations. The new equipment will cost $1,800,000 now and will last eight years and have a salvage value of $200,000 at the end of eight years. If this new equipment is purchased, the current, older piece of equipment will be scrapped for $50,000 in cash proceeds from a scrap metal dealer. The company applies the straight-line method of depreciation. The new equipment will enhance assembly operations and save the company $312,000 in cash operating expenses each year for eight years. (That means income will increase since expenses decrease.) However, at the end of year 4, the equipment will require a special cleaning and maintenance that will cost $135,000 and that will be paid in cash. The new equipment will also require the dedication of $90,000 in working capital at the beginning of the assets useful life and that working capital will be released at the end of the eighth year. The minimum required rate of return established by management for all projects is 8%. And the companys current ROI is 9%. Ignore income taxes.

Required:

a) Calculate the net present value of this proposal. Show all calculations. In other words, map out all cash inflows and cash outflows by date or year # and label them. You will need to use footnotes to support your final answer. State your assumptions about why you would include depreciation expense or not include depreciation expense.

b) Calculate the simple rate of return of this proposal. Show all calculations.

c) After reviewing your results from parts (a) and (b), and with the new knowledge that the annual cost savings of $312,000 represent direct labor costs, do you recommend that Cool Air Generations accept or reject this opportunity to purchase the equipment, and why?