Question
Sandy Ichton, a manager for the Manufacturing Company, has the opportunity to upgrade the equipment in the Midwest division by replacing and upgrading some of
Sandy Ichton, a manager for the Manufacturing Company, has the opportunity to upgrade the equipment in the Midwest division by replacing and upgrading some of its machinery. The cost of the upgraded machinery will be $420,000 and will be depreciated using the straight-line method. The machinery is expected to have a useful life of 7 years and no residual value at the end of the 7 years. The firm requires a minimum after-tax rate of return of 14% on investments. Sandy estimates annual net cash operating savings for this equipment of $125,000 before taxes and an investment in working capital at the beginning of the project of $2,500 that will be returned at the project's end. The tax rate is 35%.
1. | Calculate the net present value of this equipment. |
2. | Calculate the accrual accounting rate of return based on net initial investment for this equipment. |
3. | Should Sandy accept the project? Will Sandy accept the project if her bonus depends on achieving an accrual accounting rate of return of 14%? How can this conflict be resolved? |
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