Problem 2

Beta Company is considering the purchase of a new equipment to automate part of their manufacturing process. The old system can be sold for $55,000. The new system will cost $4,500,000 and will last for 10 years. The new equipment will have a salvage value of 45,000 at the end of its useful life. The companys cost of capital is 14%. A working capital of $100,000 is necessary in the first year and another $150,000 is needed at the end of year 7 to run the new equipment. The investment in working capital will be recovered at the end of the useful life. The new equipment will increase production and sales by 15% annually. Unit selling price and variable cost per unit will remain unchanged.

Selling price per unit	$25
Variable cost per unit	$18
Units produced and sold (before investment in new equipment)	250,000

The annual cash savings associated with the system are as follows:

Decreased waste	$150,000
Increased quality	200,000
Decrease in operating costs	125,000
Increase in on-time deliveries	25,000

Required:

a. Calculate the NPV for the new equipment.

b. Should the company invest in this new equipment based on the NPV analysis? Explain.

c. Calculate the payback period for the new equipment.